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The global bond markets are undergoing dramatic changes, with both Japanese government bond yields and US Treasury yields rising notably.

Yields on long-dated Japanese government bonds rose to new records on Wednesday while US Treasury yields have stayed elevated, with the yield on 30-year Treasury bonds hitting 5%, according to a Reuters report.

Analysts are seeing this as a warning sign for the western bond markets. Deepak Shenoy, CEO of Capitalmind posted on social media platform X on May 20: There is actually something horrible happening to debt markets around the world (India's been ok though) with yields rising. The problem child will be Japan.

While dynamics in each country differ, the underlying factors remain largely the same: markets are adjusting themselves to a world of higher inflation and growing fiscal pressures.

A lack of buyers at the Ministry of Finance's sale of 20-year JGBs on Tuesday resulted in the worst auction result since 2012, suggested a Reuters report. The Japanese 30-year yield rose to as high as 3.185%, a new record. The 40-year yield touched an all-time peak of 3.635%.

This comes as a surprise, especially since Japan has had the lowest bond yields in the developed markets for years. In order to fight deflation and stimulate growth, the Bank of Japan (BoJ) has kept interest rates near zero and aggressively bought government bonds. But now, the landscape is shifting.

Given high inflation in the aftermath of the Covid-19 pandemic, the BoJ decided to gradually scale back its bond-buying programs and allow interest rates to rise. For three years in a row, Japan’s inflation has been above the Bank of Japan’s 2% target, with the figure rising by 3.6% year-on-year in March 2025. Additionally, concerns about new fiscal stimulus ahead of a Japanese upper house election slated for July have also driven yields. Tepid investor demand at a 20-year Japanese government bond auction turned out to be the final nail in the coffin, pushing yields to decadal highs.

"Japanese bond yields have been steadily rising with the expectation of incremental tightening from BoJ. Post August of last year when there was a surprise hike, with inflation firming up, BoJ hiked once again in January 2025 and has kept the narrative more hawkish," explained Anitha Rangan, Economist, Equirus Securities.

Additionally, she said that Japan's weak fiscal position (Debt-to-GDP over 250%; it has remained over 200% for over a decade), with elections and fiscal giveaways has further led to rise in bond yields. "Notably, a reversal in deflation and rise in bond yields has come after more than a decade. With weaning of monetary stimulus we could see this trend continue," she added.

Meanwhile, in the US, too, focus is back on the yields after Moody’s last Friday announced it was downgrading the US to Aa1 from Aaa, with the yield on 30-year Treasury bonds hitting 5%.

Moody's downgrade has stoked concerns about the country's $36 trillion debt pile, with US President Donald Trump pushing for tax cuts that could worsen the debt load by $3 trillion to $5 trillion.

"US debt downgrade, you should know that credit ratings understate credit risks because they only rate the risk of the government not paying its debt. They don't include the greater risk that the countries in debt will print money to pay their debts thus causing holders of the bonds to suffer losses from the decreased value of the money they're getting (rather than from the decreased quantity of money they're getting)," said Ray Dalio, founder of Bridgewater Associates. At the current rate, he predicts the US will be $50 trillion in debt by 2035.

Additionally, while inflation in the US has cooled from its peak, it remains above the US Federal Reserve’s comfort zone. Recent tariffs by Trump has also distorted the possible trajectory of economic growth and inflation, with markets now expecting interest rates to stay "higher for longer," which supports higher yields.

The rising bond yields in Japan may also have a cascading impact on US bonds. Since Japanese investors are one of the biggest holders of US bonds, amounting to $1.13 trillion, the rise in Japanese yields will be most felt in the US Treasury market, predicts Vishal Goenka, Co-founder of IndiaBonds.com.

"The fear is that Japanese investors may now sell UST to buy JGBs at yields not seen since 2000. This may put further pressure on US yields for the long end of the curve and cause second-order effects on global yields going higher," Goenka said.

Goenka believes India remains relatively insulated from global yield movements as of now due to its strong domestic and fiscal position. However, he cautioned that we are not immune to any sharp global exogenous shocks to government bond yields.

"The current market pricing has extreme bullishness built in with 10-year G-Sec hovering around 6.25% and expectations of imminent rate cuts by RBI. At these levels it’s important to watch global developments and risk-return tradeoff is skewed to the downside - implying yields are more likely to move higher than lower in the medium term," he added.

Abhishek Bisen, Head Fixed Income, Kotak Mutual Fund said that Japanese investors prioritize liquidity over yield, mostly investing in DM markets. "Rising JGB yields may reduce global demand for EM debt, but direct Japanese outflows from Indian bonds are unlikely. Indian debt remains attractive due to strong macro fundamentals, lower rates, and a stable currency," Bisen noted.

However, the immediate impact of the rising US bond yields was visible in the form of massive foreign investor selling on Tuesday, with ₹10,000 crore outflows recorded in the Indian stock market. Yesterday’s FII sell figure of ₹10,016 crore is a major reversal of their big buying in May, and if this persists, it has the potential to impact the market, cautioned Dr. VK Vijayakumar, Chief Investment Strategist, Geojit Investments.

He explained that a combination of many factors may be responsible: credit rating downgrade of US sovereign debt and the consequent spike in US bond yields, spike in Japanese Govt Bond yields, rising COVID cases in some parts of India and reports of a possible Israel attack on Iran are doing the rounds.

The 30-year JGB yield spiking to 3.14% in the backdrop of the US 30-year yield spiking to 5% a couple of days back sends a feeling of disquiet in financial markets, he said. "This may not create any near-term impact, but is bound to have some medium to long-term consequences. Investors have to exercise caution," advised Vijayakumar.

Disclaimer: This story is for educational purposes only. The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.

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