Japan 10-year bond yield hits 3%, highest since October 1996

On Tuesday, Japanese government bonds experienced a significant surge in demand, leading to a 10-year bond yield reaching 3.000 percent for the first time since October 1996. This sharp increase in yield was primarily driven by growing expectations of another interest rate hike by the Bank of Japan, aimed at curbing inflationary risks, as well as persistent concerns about Japan's deteriorating fiscal health.

The bond yield crossed a critical threshold shortly after the beginning of the afternoon trading session, just a day after government ministries and agencies submitted their budget requests for the upcoming fiscal year. These requests totaled an unprecedented 143 trillion yen ($890 billion), amplifying worries about Japan's fiscal situation under Prime Minister Sanae Takaichi's expansionary fiscal policy.

The rise in bond yields was also influenced by renewed concerns over inflation, following the West Texas Intermediate crude oil futures prices crossing the $85 per barrel mark, due to renewed tensions between the United States and Iran. Analysts, such as Masahiro Ichikawa, chief market strategist at Sumitomo Mitsui DS Asset Management Co., emphasized the importance of the government's response to market signals and its ability to manage the situation, as key issues such as the budget size, revenue sources, and spending control would come under scrutiny.

Despite the yield's sharp increase, the U.S. dollar briefly managed to surpass the 160 yen level, trading within the upper 159 yen range throughout Tokyo trading hours. The yen selling pressure was counterbalanced by buying as U.S. Treasury Secretary Scott Bessent's remarks, along with his meeting with Bank of Japan Governor Kazuo Ueda and Finance Minister Satsuki Katayama, fueled speculation about a possible central bank rate hike in the current month.

At 5 p.m., the dollar traded at 159.98-160.00 yen, slightly higher than the previous day's rates in New York (159.68-78 yen) and Tokyo (159.56-58 yen). The euro remained steady, quoted at $1.1595-1596 and 185.50-54 yen against the greenback, while Tokyo stocks ended the day mixed, with investor sentiment impacted by Middle East tensions.

However, a year-on-year increase in Japanese companies' capital spending during the April-June quarter bolstered the broader market. The Nikkei Stock Average, representing the 225 largest Japanese companies, closed down 96.59 points, or 0.15 percent, at 66,215.34 from Monday's close. The broader Topix index managed to finish 25.57 points, or 0.62 percent, higher at 4,181.86.

In the top-tier Prime Market, electric power, gas, and mining shares led the gains, while service and nonferrous metal issues suffered notable declines. Dealers suggested that sector rotation might be in play, although they anticipate it to be a short-lived trend.