On Wednesday, November 11th, global bond markets experienced significantly increased volatility. Japanese government bond yields rose sharply, with the benchmark 10-year yield climbing to around 2.795%, an increase of approximately 10.5 basis points from the previous trading day; the 5-year yield rose to 2.195%, and the 2-year yield rose to 1.86%. This trend primarily followed the overnight sell-off in US Treasuries, with the 2-year US Treasury yield jumping by approximately 18 basis points to 4.74%, one of the largest jumps since April 2025. The trigger was the US October Consumer Price Index (CPI), which rose 0.4% month-on-month, with core CPI rising 0.3% month-on-month, both exceeding market expectations. In the previous few trading days, Japanese government bonds had strengthened due to safe-haven demand triggered by volatility in risk assets, leading to a slight decline in yields; the current trend shows a clear reversal.

US inflation data reshapes interest rate expectations.

Following the release of US October inflation data, the market adjusted its pricing of the Federal Reserve's policy path. Month-on-month data remained relatively high for the third consecutive month, with core inflation maintaining a pace of 0.3%, indicating that price pressures on housing, food, and other items remain persistent. Due to a data gap from the same period last year, the authorities did not release a complete year-on-year reading, but September's year-on-year figure had already reached 3.7%, still significantly higher than the long-term target of 2%. Federal Reserve officials stated before the data release that if the core month-on-month figure approached or reached 0.3%, a more aggressive response to inflation would be needed. Based on this, the market revised upward the probability of a rate hike at the December FOMC meeting, with short-term interest rate futures nearly fully pricing in a 25 basis point adjustment, while also reflecting the possibility of a larger adjustment. US short-term Treasury yields are more sensitive to policy expectations, with the two-year yield jumping significantly more than the ten-year yield, and the yield curve showing some flattening characteristics. This repricing is transmitted to other markets through interest rate linkages, with short- and medium-term Japanese government bonds also under pressure.

The Reversal Logic Behind the Previous Decline in Japanese Government Bonds

The recent rise in Japanese government bond yields is essentially a correction of the previous decline driven by safe-haven demand. During periods of volatility in risk assets, investors increased their allocation to sovereign bonds, pushing up Japanese government bond prices and lowering yields, at times exceeding the scope that could be explained by changes in fundamentals. As risk sentiment showed signs of recovery, safe-haven buying weakened, and yields subsequently rebounded. Shinichiro Tsunoda, head of foreign exchange and interest rate strategy for Japan at Barclays, pointed out that the broad-based recovery in risk sentiment "indicates that we are in the midst of a reversal from the earlier sharp decline in yields." He also believes that there was a certain degree of overcorrection in the previous decline, and yields have room to recover some of the losses. From a market structure perspective, the two-year Japanese government bond, as a monetary policy sensitive end, reacts more directly to changes in global short-term interest rate expectations; while the ten-year bond reflects a more comprehensive pricing of medium- and long-term inflation and growth expectations. Currently, the absolute level is still lower than that of the same-maturity US bond, but the relative magnitude of changes remains highly correlated with cross-market interest rate spread adjustments.

Discussion on the Bank of Japan's Policy Path and Neutral Interest Rate

The Bank of Japan (BOJ) maintained its policy rate at 1.25% at its October policy meeting, the highest level since 1995, while also acknowledging that underlying inflation had reached its 2% target. The meeting minutes summary showed that some members believed excessive caution was unwarranted and that the policy rate needed to be raised to a neutral level as soon as possible. Governor Kazuo Ueda also indicated at the post-meeting press conference that there was a possibility of another adjustment in December. Swap contract pricing currently implies approximately a 70% probability of a December rate hike. BOJ staff estimate the neutral interest rate range to be roughly between 1.1% and 2.5%, with some members mentioning around 2%. This contrasts with US data: US inflation stickiness has strengthened tightening expectations, while Japan is in a transitional phase from ultra-loose to neutral. While the exchange rate and import price channels may constitute an indirect transmission mechanism, the core of the BOJ's decision-making remains a comprehensive assessment of domestic underlying inflation, wage dynamics, and financial conditions.

Yield curve shape and cross-market linkages

Observing this round of adjustments, the upward movement of the short end of the Japanese government bond curve was slightly less than that of the medium and long ends, but the overall slope change was limited. In the US, the spread between the two-year and ten-year yields narrowed to approximately 25 basis points, indicating a more aggressive pricing of policy expectations at the short end. Looking at cross-markets, upward revisions to US interest rate expectations affect demand for Japanese government bonds through carry trades and capital flows, especially amplified by the fading safe-haven premium during periods of rising risk appetite. Currently, the Japanese two-year yield is around 1.86%, still significantly lower than the US level for the same maturity, with the spread remaining at a relatively high level. Under this structure, any further repricing of the US policy path is likely to continue to influence Japanese short-term pricing through expectations, while the long end is more constrained by domestic discussions on the neutral interest rate and the pace of fiscal supply.