Bank of Japan faces a policy dilemma as government bond yields keep hitting new highs

Core Viewpoint - The Bank of Japan is facing a critical decision regarding its monetary policy as rising government bond yields threaten to disrupt its normalization process and impact economic growth [1][3]. Group 1: Bond Yields and Economic Impact - The yield on the benchmark 10-year Japanese government bonds (JGBs) reached 1.917%, the highest since 2007, while the 20-year and 30-year JGB yields hit 2.936% and 3.436%, respectively, marking levels not seen since 1999 [2]. - Japan's inflation has remained above the Bank of Japan's 2% target for 43 consecutive months, complicating the decision to raise rates amidst rising bond yields [3]. - Rising bond yields are expected to increase borrowing costs, further straining Japan's fiscal situation, which already has the highest debt-to-GDP ratio globally at nearly 230% [4]. Group 2: Government Stimulus and Debt Concerns - The Japanese government is preparing to implement its largest stimulus package since the pandemic, which raises concerns about the country's increasing debt levels [5]. - The new debt issuance of 11.7 trillion yen to finance the supplementary budget is 1.7 times larger than that issued under the previous administration [5][6]. Group 3: Global Market Implications - The unwinding of yen-funded leveraged carry trades due to a hawkish BOJ rate hike and disappointing U.S. macro data led to a significant sell-off in global stocks, with Japan's Nikkei index dropping 12.4% in August 2024 [7]. - Rising Japanese yields have narrowed the rate differential, raising concerns about another potential unwind of carry trades, although experts believe a repeat of the 2024 market meltdown is unlikely [8][9]. - Structural flows from retail allocations in pension funds and life insurance are expected to anchor foreign holdings, making large-scale repatriation of funds into Japan improbable [10].