Japan's 10-Year Bond Yield Nears 3% as Record Budget Plans Face Market Test

Japan's government bond market is under the spotlight this week as the 10-year yield touched 2.95% on Monday, its highest level since September 1996. The move brings the benchmark closer to the psychological 3% mark, raising the stakes for Tuesday's auction of 2.6 trillion yen in 10-year debt.

The sale comes as budget requests from ministries for fiscal 2027 are projected to hit a record 140 trillion yen, far exceeding last year's all-time high of 122.3 trillion yen. Prime Minister Sanae Takaichi has said she aims to cap new bond issuance at around 40 trillion yen for that year, seeking to reassure investors amid a fourth consecutive year of record spending and a planned tax cut on food purchases.

Debt-servicing costs are also climbing. The finance ministry expects them to rise 17% to a record 36.64 trillion yen in the next fiscal year, reflecting an assumed interest rate of 3.8% — the highest in 29 years.

Shorter-dated yields are also at multi-decade highs, with the 2-year yield at 1.75% and the 5-year at 2.21%, as markets bet on faster rate hikes by the Bank of Japan. Comments from US Treasury Secretary Scott Bessent, who said he expects BOJ Governor Kazuo Ueda to "do the right thing," have added to the upward pressure on yields.

Analysts say the current yield levels are attractive, but expectations of further increases are keeping demand weak. The past two 10-year auctions have seen tepid interest. "With various cues putting upward pressure on JGB yields, it would be hard to actively bet on the 10-year bonds," said Yusuke Matsuo, senior market economist at Mizuho Securities.

Tuesday's sale will be followed by a 30-year auction on Thursday. The results will be watched closely not just in Japan but globally, as rising borrowing costs in Tokyo are seen as a cautionary tale for other heavily indebted nations. Investors are also juggling shifting expectations for the Federal Reserve and the outcome of a two-day G20 finance leaders' meeting.

"The auction takes place at a delicate time ahead of various market-moving cues both inside and outside Japan," said Masahito Sugawara, senior strategist at Daiwa Securities.