Transcript

Amada Agati:  

Hi everyone, and welcome to a special edition of Adding Alpha. Japanese markets appear to be in a bit of a jam – bond yields are spiking, the yen is strengthening on potential currency intervention talks, and Japanese equities are on shaky ground. Today, we’re breaking down what’s driving the turmoil and what it may mean for investors.

Japan is currently experiencing a convergence of political risk, fiscal uncertainty and market stress that is unsettling many global investors. While some market prognosticators have drawn comparisons to the volatile market environment in the U.K. back in 2022, we believe there are important distinctions.

When Japan’s Prime Minister Sanae Takaichi called for snap elections on February 8th, markets immediately reacted. Sovereign bond yields jumped, and prediction markets now assign an approximately 60% chance that the PM will leave her post by year end, a setup that certainly harkens back to the short-lived tenure of British Prime Minister Liz Truss in 2022.

A quick refresher: Truss took office with ambitious fiscal stimulus proposals, markets questioned the credibility of the plan, the pound collapsed, gilt yields spiked and her term became the shortest in U.K. history.

Japan is now facing a similar dynamic: fiscal stimulus proposals + elevated inflation = markets pushing back hard.

Since the announcement, Japan’s sovereign yield curve has been rapidly repriced. 30- and 40-year JGB yields spiked to record highs. The 40-year yield reached ~4.21% - the largest one-day move ever in that tenor.

Now, for one of the key distinctions, in our view – in Japan, foreign investors only own about 10% of JGBs and the Bank of Japan owns ~45%. In the U.K., both foreign ownership and the Bank of England’s shares are each closer to 30%.

In Japan, most foreign ownership is concentrated in T-bills, not long-term bonds. And what type of foreign investors are buying Japanese T-bills? Hedge funds! So, when investors unwind leveraged positions, that volatility ripples quickly through global markets.

It’s this dynamic that is driving the current market reaction – the purple haze of Japan’s domestic fiscal policy is spilling into global fixed income markets.

On the monetary policy front, the Bank of Japan is in a tough spot. It did not choose to raise interest rates at its January 22nd meeting, likely because core inflation is running near 2.9% and showing little sign of moderation. The BOJ doesn’t meet again until mid-March – a lot can happen between now and then, which is why markets expect foreign currency intervention to help prevent further yen weakness.

Intervention may buy the yen some time, especially when the purple haze of policy uncertainty is getting thicker; but it’s not a permanent or long-term solution in our view, since Japan is facing both a debt AND inflation problem.

If the outcome of the snap election goes against the Prime Minister, markets may question the credibility of fiscal policy even more. That could trigger a renewed crisis of confidence, not unlike what we saw in the U.K. back in 2022.

In 2025, Japan lagged other international markets, but still outperformed the S&P 500. Despite all this renewed turmoil, equities in Japan have continued to outperform in early 2026, mostly thanks to yen weakness.

That said, there are clearly some risks mounting in our view: companies in Japan carry nearly double the leverage of those within the S&P 500 – a major vulnerability if markets continue to demand higher long-term rates. Plus, the BOJ is still technically in tightening mode.

Additionally, the corporate earnings growth rate in Japan looks respectable, it’s expected to be about 9% in 2026; but, it’s coming off a negative rate in 2025 and is considerably less than the 14–15% expected S&P 500 growth rate.

In summary, Japan’s bond market is sending a message: fiscal credibility and policy coordination are important to investors and markets aren’t willing to give policymakers a lot of wiggle room in this environment.

We’ll continue to monitor this situation closely and keep you updated as conditions evolve.

Thanks for watching!