One for all, and JGBs

Misery is… 

Bond investors worry about three things. These are: bonds being repriced by unexpected changes in central bank interest rates; inflation eroding the real value of bond returns; and increases in government supply – due to higher budget deficits - causing bond yields to move high enough to attract investors to buy the additional debt. Currently, at least two of those three issues are evident across markets. And they are most evident in Japan and the UK. Or at least that is how the consensus narrative is framed. In the case of Japan, the concern is that rising inflation (at last), a reducing BoJ balance sheet and changes in the structural demand for long-term government bonds are driving yields higher. This could mean that global capital flows will be impacted by higher Japanese yields – investors in Japan having more incentive to invest in their own market rather than overseas, and other investors having to close the ‘yen carry trade’. In short, higher Japanese bond yields are seen as a potential cause of higher global bond yields. For the UK, there are similar concerns. Inflation is obstinately high, making it hard to cut interest rates, and the fiscal outlook is bleak.

…global 

It is important to understand there is a significant cross-market correlation of yields in G7 government bond markets. Since 2022, yields have gone up everywhere. Compared to the level of 10-year government bond yields at the end of 2007 (a proxy for the beginning of the global financial crisis and the era of quantitative easing), global bond yields are barely back to those levels. US Treasury yields went higher than their end-2007 level and have stayed above that level since mid-2023. But other markets are only just back to those levels - UK gilts are 11.6 basis points (bp) higher while Japanese government bonds are still 6.2bp lower, with German Bunds a substantial 160bp lower. There has been nothing exceptional about the move in Japanese yields. Yield levels have normalised to their pre-global financial crisis levels and are now more consistent with long-term trends in nominal GDP growth. It was 2008 to 2022 that was the exception. Still, no-one wants to see yields move even higher.

Bonds are bonds 

Given the liquidity in government bond markets, the role of government bonds as so-called risk-free assets, and the mobility of capital, it is understandable how correlated yields are. It is also important to remember that Japanese yields have always been lower – a product of Japan’s prolonged disinflationary backdrop that followed the stock market crash and the property bubble bursting at the end of the 1980s. It has also been the market with the lowest level of yield volatility in the G7. I did a simple analysis of JGB yields: regressing the JGB yield on other government bond markets yields (US, Germany and the UK). The correlations are high and back-fitting Japanese yields based on the regression results produces a good approximation of the actual yield (changes in Japanese yields are explained mostly by shifts in global bond yields).

Until recently that is. Since the end of 2023, JGB yields have moved much higher than levels suggested by yields in other markets. The divergence coincided with the first BoJ interest rate adjustment. Since then, with Japan’s inflation rate gradually increasing, investors have taken the view that Japanese interest rates and bond yields cannot be as far below levels in other markets as they have been historically. The fact the BoJ – which did more quantitative easing than anywhere else – is now reducing its balance sheet and that Japanese insurance companies and pension funds are generating less demand for longer duration government bonds, is creating an idiosyncratic risk premium in the JGB curve. Japan, as a country, is very asset-rich, having built up international assets over time because of its persistent current account surplus. But its government debt-to-GDP ratio is higher than any other G7 country (gross debt is equal to 216% of GDP, according to the OECD). This is an additional concern for the market. Rest assured though, there is no Japanese bond crisis, but local factors have become more dominant. This means investors need to pay more attention to Japan’s macroeconomic situation in case there are implications for capital flows and bond yields elsewhere, as Japanese investors are major creditors in US and European markets.

UK parochialism 

A similar analysis of the UK gilt market suggests a greater role for idiosyncratic influences on yield moves – the Chancellor Rachel Reeves being visibly upset in the House of Commons being a classic example. But significantly, and as I have discussed before, the UK fiscal outlook is a real concern with the current government unable to move forward on reforms to welfare payments and in danger of breaching its own fiscal rules. September 2022 showed us the bond vigilantes do not like gambling with taxes and spending to boost economic growth. A more thought-out and credible fiscal and growth plan is needed, but it is still not evident. Moreover, the UK’s inflation profile is disappointing. Consumer price inflation jumped to 3.6% in June, from 3.4% in May. Remember, before the last budget impacted inflation, the annual rate was 2.6% in March. There is an argument that inflation will fall sharply once those budget-related items fall out in 2026, but we do not really know what is in store for taxes later this year and the risk is that inflationary expectations remain high. It might need a much slower economy to break the back of UK inflation, which is not good for the fiscal outlook. 

Riskier but positive returns in gilts 

As such, gilt yields are likely to continue to be more volatile than yields in other markets. Amongst the major government bond markets, the variance in daily changes in 10-year yields over the last five years has been the highest in UK gilts and Italian government bonds. The lowest has been in JGBs, despite all the market angst. A conclusion to take away is that, given the level of UK yields, a bullish view on duration could be executed through a position in UK bonds. Funnily enough, parts of the gilt market have outperformed European government bonds this year - the seven-to-10-year maturity bucket has a total return of 3.6% for the UK and 1.4% for a European government bond index.

And the unknown

Then there are specific concerns about US Treasuries. There were rumours in the middle of the week that President Donald Trump was about to fire Federal Reserve (Fed) Chair, Jerome Powell. It is no secret that Trump wants the Fed to cut rates. The panic scenario is that Powell is replaced by someone more subservient to Trump and all normal procedures for setting rates - Federal Open Market Committee analysis and voting - are upended. Such a scenario would see higher bond yields through a steeper curve, and a weaker dollar. Break-even inflation rates would rise further as well, as this would be a potentially inflationary situation. There would need to be a bigger risk premium in US rates given the uncertainty around monetary policy – with implications for yields elsewhere and exchange rates. While I doubt that even Trump would go down this route, if it did transpire, the impact on risky assets would be negative. Imagine, higher inflation through tariffs and overnight rates slashed to zero or negative in real terms. Inflation protection is needed more than ever today. Break-even inflation rates continue to edge up in US markets.

Bond party 

Global bond markets are certainly not boring. We have yield. We have volatility. We have important macro influences. We have divergences as well. In local currency terms, total returns from the German and Japanese government bond markets are negative in 2025; from the US and UK markets they are positive – showing the power of carry in higher-yielding markets. For Japanese investors, it already makes sense to stay invested in their home market as the cost of foreign exchange (FX) hedging means yields from US Treasuries or European government bonds, hedged into yen, are below those available in the JGB market. The Bank of Japan overnight rate remains low – at 0.5% - which means there is a near 400bp annualised cost for Japanese investors to hedge their US currency exposure. In contrast, investors in Europe and the US can pick up additional yield by holding foreign exchange hedged positions in Japanese bonds. Many will not, of course, because they fear Japanese yields are going higher, but if they do it is likely that a good part of the move would be driven by global bond yields moving higher.

Risks and opportunities 

There are genuine concerns about inflation – especially in the US and the UK. There are genuine concerns about the fiscal outlook – everywhere. But at the same time, inflation in Europe is back to target and the newly strong euro is helping keep inflation under control. China has no inflation and is exporting deflation again as it ramps up exports to the rest of Asia and Europe to compensate for losing market share in the tariff-protected US. Differentials in inflation trends will play out in divergent return opportunities in global fixed income markets.

There are genuine concerns about structural changes in the demand for bonds, particularly longer duration assets. Yet, governments are responding by issuing fewer longer-dated bonds which might mean that the long end will start to offer relative (scarcity) value at some point. The demand for fixed income is huge because of the income opportunities available today and yields are at attractive levels. Buying duration on spikes higher in yield, for long-term investors, remains an attractive option if Trump refrains from upending the global monetary stability by violating the Fed and subordinating the fiat system to crypto. It has never been more exciting to be in the bond market.

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, AXA IM, as of 17 July 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.