Japan’s bond market is causing ripples across global financial markets, with rising long-dated government bond yields threatening to trigger capital flight from the United States and unwind the popular carry trade strategy. The carry trade is a strategy where investors borrow in low-yielding currencies like the yen to invest in higher-yielding assets abroad.

Yields Surge to Multi-Year Highs

Yields on Japan’s 40-year government bonds rose on May 28, 2025, with demand at recent auctions reported to be the weakest since November, according to Reuters, quoted on CNBC. These bonds hit a record high of 3.689% last Thursday and were last trading at 3.318% — marking an increase of nearly 70 basis points so far in 2025.

Meanwhile, 30-year bond yields have surged more than 60 basis points this year to 2.914%, while 20-year yields have climbed over 50 basis points. These levels bring long-dated yields dangerously close to all-time highs.

Structural Drivers Behind the Shift

The steepening of Japan’s yield curve is driven by a fundamental change in investor behavior. Japanese life insurers — traditionally large buyers of 30- and 40-year bonds due to regulatory needs — have largely fulfilled their purchasing obligations. This has led to a falloff in demand, per the CNBC article.

Compounding the issue, the Bank of Japan has been scaling back bond purchases as part of its broader monetary policy pivot, leaving a demand gap that private investors have not filled. This supply-demand imbalance is expected to continue putting upward pressure on yields. Such moves can add to the strength of Invesco CurrencyShares Japanese Yen Trust (FXY Quick QuoteFXY - Free Report) .

Capital Repatriation Risk Looms

The rising yields on Japanese government bonds (JGBs) could prompt Japanese investors to repatriate capital from overseas, particularly from the United States. Albert Edwards, global strategist at Societe Generale, warned on CNBC that if the trend continues, it could lead to a “global financial market Armageddon.”

David Roche of Quantum Strategy cautioned that tightening global liquidity, paired with rising long-term rates, could slash global growth to just 1% and prolong the bear market across multiple asset classes, as quoted on CNBC.

A strengthening yen, driven by higher domestic yields, would further reduce the incentive for Japanese investors to hold foreign assets — especially in U.S. tech stocks, which have seen significant Japanese investment. The tech-heavy ETF Invesco QQQ Trust (QQQ Quick QuoteQQQ - Free Report) may come under pressure due to this situation.

David Roche of Quantum Strategy highlighted Japan’s status as the world’s second-largest creditor, with net external assets reaching a record ¥533.05 trillion ($3.7 trillion) in 2024. This adds a layer of vulnerability to global markets. He also noted that this potential capital shift reflects a broader “end of U.S. exceptionalism,” with similar patterns emerging in Europe and China.

Good Times Ahead for Japanese Small-Cap Stocks?

A strengthening yen could be a headwind for Japan’s export-heavy companies, but it may benefit domestically focused Japanese stocks. iShares MSCI Japan Small Cap ETF (SCJ Quick QuoteSCJ - Free Report) and WisdomTree Japan SmallCap Dividend Fund (DFJ Quick QuoteDFJ - Free Report) should benefit out of this situation. Top of Form

Large Caps to See a Double-Edged Sword?

Increased domestic investment demand could support large-cap Japan equity ETFs like iShares MSCI Japan ETF (EWJ Quick QuoteEWJ - Free Report) , particularly if funds shift away from foreign markets. But then, Japan’s indexes are export-oriented. If the yen strengthens meaningfully, Japan’s export-oriented companies may take a hit.

U.S. Bond ETFs: Could Be at Risk

If Japanese investors offload U.S. Treasuries or bond ETFs (like (TLT Quick QuoteTLT - Free Report) to repatriate funds, prices could drop and yields rise. Long-duration bond ETFs will be hit hardest due to their sensitivity to interest rate changes.