Long-term yields hit 30-year high on fiscal concerns, Middle East tensions

2026-07-08

Long-term yields are under renewed upward pressure at their highest level in about 30 years. Concerns over Sanae Takaichi's expansionary fiscal policy have been compounded by instability in the Middle East. If fiscal worries intensify further, long-term yields could test 3%.

Wariness over draft of basic policy guideline

In Japan's bond market on the 8th, the newly issued 10-year government bond yield at one point rose 0.025 percentage point from the previous day to 2.87%. That was the highest level since September 1996, when benchmark issues with heavy trading volume were treated as long-term yields, with both domestic and overseas factors pushing rates higher.

Market grows cautious on draft revisions

What markets focused on was the draft of the government's basic policy on economic and fiscal management and reform, the so-called bone-too policy. The draft shown on June 30 assumed additional fiscal spending from fiscal 2027 onward at an effective annual pace of about 10 trillion yen. At the same time, wording on fiscal consolidation that had been included through fiscal 2025 was removed and replaced with sustainability.

On the Bank of Japan's monetary policy, the draft said 'appropriate monetary policy management' was 'extremely important' and called for close coordination between the government and the BOJ. In addition to the perception that this would lead to looser fiscal discipline, views spread that it was intended to restrain the BOJ as it continued raising interest rates, adding to upward pressure on yields.

The government moved to contain the fallout. Economic and fiscal policy minister Minoru Kiuchi said at a post-Cabinet meeting press conference on the 7th that 'this is a misunderstanding and differs from the draft's intent.' The Asahi Shimbun reported that evening that the government was considering revising some wording related to monetary policy in the draft of the basic policy guideline.

Some in the market also see the move as reflecting the government's sense of crisis over rising yields. Still, Takuya Onizawa, chief rates strategist at SMBC Nikko Securities, wrote in a report dated the 8th that once the view took hold that the BOJ's rate hikes would be constrained as the government seeks a stronger economy, it would be quite difficult to overturn that perception.

Middle East tensions lift crude oil

As for external factors, tensions between the United States and Iran in the Middle East have flared up again. Early on the 8th, U.S. Central Command said it had launched a powerful attack in retaliation for Iran's assault on a merchant vessel sailing through the Strait of Hormuz. Front-month U.S. crude futures briefly rose to the upper $72-per-barrel range in morning trading on the 8th Japan time, reaching their highest level in two weeks.

U.S. Central Command said in the morning of the 8th Japan time that the operation had been completed. It said it attacked more than 60 small boats of the Islamic Revolutionary Guard Corps, along with Iranian air defense systems and coastal radar facilities in and around the Strait of Hormuz. Although crude prices have fallen from above $110 a barrel in March and April, if they remain elevated they could push up domestic prices and may also force additional fiscal spending as a countermeasure to higher oil costs.

The Takaichi administration has set out a growth strategy that targets 17 strategic fields and calls for public and private investment of more than 370 trillion yen by fiscal 2040. In QUICK's special July survey released on the 8th, when asked about the impact of this growth strategy on the Japanese economy, the most common answer across all industries, at 61%, was that it would 'slightly boost Japan's growth potential.' Another 20% said it would 'greatly contribute to revitalizing economic activity and lead to strong growth for the Japanese economy.'

While the industrial sector has high expectations for the growth strategy, there is also a risk that if the effects are insufficient, only government debt will swell. Takuya Onizawa, bond strategist at Mitsubishi UFJ Morgan Stanley Securities, said long-term yields could rise further if fiscal concerns come into focus.

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