New high in the past 30 years! The 10-year Japanese government bond is approaching the key level of 3%, and the sharp drop in Japanese stocks is beginning to show "immune breakdown" to rising interest rates.

For more than a year, the yield on Japan's 10-year government bonds has risen from around 1% to nearly 3% today, approaching a key level. The yield on 30-year government bonds has also accelerated after breaking through 3% in January, subsequently breaking through two psychological resistance levels of 3.88% and 4%. At the same time, the Japanese stock market, which has largely ignored the continuous rise in interest rates over the past year, seems to be ending its "honeymoon period". Concerns are growing about whether the "normalization of Japanese interest rates is turning from a blessing to a curse." May 18th This day is destined to be written into the history of the Japanese financial market. When Japanese Prime Minister Takamiya Saonae publicly stated in Tokyo that the government has begun to study fiscal measures and will include the preparation of a 2026 fiscal supplementary budget in its considerations, the reaction of the bond market was like a raging fire: the benchmark 10-year Japanese government bond yield skyrocketed shortly after the opening bell, exceeding 10 basis points to reach 2.8%, hitting the highest level in nearly 29 and a half years since around October 1996; the yield on 30-year government bonds surged by nearly 20 basis points at the end of last week to exceed 4.20%, hitting a historical high since the issuance of bonds at this term in 1999; the yield on 5-year government bonds also hit a historical high last week. As of May 19th, the Nikkei 225 index closed at 60,550.59 points, falling for the fourth consecutive trading day. Just on May 15th, the Nikkei 225 index plummeted by 1.99% (1244.76 points) to close at 61,409.29 points, marking the largest single-day decline in the current period. As of Wednesday, at the time of writing, the Nikkei 225 index fell by 1.13% in early trading. Atsushi Sato, General Manager of the Securities Investment Department of Fukoku Mutual Life Insurance, bluntly commented: "Rising interest rates are putting pressure on high-valued AI-related stocks. It is not surprising that the market is showing a cautious mood towards heavily indebted companies, and market choices in the future may become more stringent." Avalanche in the bond market: a double squeeze of "internal and external troubles" The Japanese bond market is facing a precise squeeze of "internal and external troubles". On the "external troubles" front, the Iran war continues to drive international oil prices to remain high, and concerns about global inflation rising again have intensified, leading to a sharp increase in bond yields in major economies such as the United States, the United Kingdom, and Europe. Last Friday, the yield on the 10-year US Treasury bonds rose to over 4.60%, hitting a new high in nearly a year, creating direct upward pressure on Japanese rates at the beginning of the week in Tokyo. On the "internal troubles" front, the impact of the fiscal outlook on Japanese government bond yields is more direct and far-reaching. On May 18th, Japanese Prime Minister Takamiya Saonae announced that the government is preparing a supplementary budget for the 2026 fiscal year, and subsequently, Reuters reported that the Japanese government is seeking sources of revenue in the direction of issuing additional deficit bonds. The market quickly became concerned about the issuance of additional government bonds. Mitsubishi UFJ Morgan Stanley Securities analyst He Tian Kai said that the market's concerns about the expanded fiscal deficit have pushed up the "fiscal risk premium", becoming an important driver of rising interest rates. Since Takamiya Saonae took office as President of the Liberal Democratic Party in October 2025, his advocacy of active fiscal policies has led to cumulative increases of over 1 percentage point in the yields of 10-year and 30-year government bonds the former rising from around 1.66% to the current level near 2.8%, and the latter rising from around 3.15% to around 4.2%. Japanese Finance Minister Mutsuki Katayama made a blunt statement last week when commenting on the resonance in global bond markets: "These developments are influencing each other, creating a cumulative effect." The Organization for Economic Co-operation and Development (OECD) recently released a report stating that by 2024, Japan's total public debt has reached about 206% of GDP, the highest among OECD members. According to data from the Japanese Ministry of Finance, the ratio of Japan's total government debt to GDP has reached nearly 250%. The report warns that Japan should rely more on measures such as raising the consumption tax to improve its fiscal situation, rather than further expanding fiscal spending. However, the Takamiya government has chosen the opposite path. 3%: an underestimated critical point For the Japanese market, the 2.8% yield on the 10-year bonds is not only the highest level in nearly thirty years, but also signifies a key psychological and technical threshold rapidly approaching. TradingKey pointed out that some institutions expect long-term yields to rise to 3% within the year. Several analysts believe that reaching a 3% yield on the 10-year Japanese government bonds is a realistic target for the second half of this year. Kiyoshi Ishigane, Executive Chief Fund Manager at Mitsubishi UFJ Asset Management Company, issued the clearest warning so far. He estimated that Japan's sustainable nominal growth rate is about 2.5% based on Japan's central bank's 2% inflation target and the Cabinet Office's estimated 0.5% potential growth rate, even in an optimistic scenario, reaching around 3%. Once long-term yields persistently exceed this level, it will "begin to impose real burdens on the real economy", with the negative effects of higher borrowing costs and declining demand gradually becoming apparent. A report released by the Japanese Cabinet Office on Tuesday showed that although the nominal GDP growth rate for the fiscal year 2025 is 4.2%, continuous selling of government bonds is steadily narrowing the gap between the growth rate and the long-term yield this narrowing "scissor difference" directly erodes corporate profit margins, making the entire economy face higher actual financing costs. Looking at a more macroscopic time scale, the significance of Japan's 10-year bond yield reaching 2.8% goes far beyond the number itself. In October 1996 the last time the yield was at this level, Japan had just experienced the pains of the bursting bubble, with the economy still struggling with bad bank loans and deflationary pressures. Now, thirty years later, returning to the same level, the structure of the Japanese economy is fundamentally different from that time: nominal GDP is growing, inflation is maintained in positive territory, the corporate sector has undergone deleveraging, and the rise in nominal income is changing consumption and investment behavior. It is this background of "different from the past" that has led the market to believe that the rise in interest rates can be absorbed over the past year. The problem is, the boundary of what can be "digested" seems to be on the verge of being breached. The end of the stock market's "honeymoon period": from synchronous rise to "triple strike" resonance The relationship between the Japanese stock market and interest rates has undergone a dramatic evolution over the past year. During the initial stages of the rise from 1% to 2% in interest rates, the Nikkei 225 index almost did not suffer any negative impact and even rose in sync. This was due to the support of market logic: the inflation-driven rise in interest rates was backed by nominal GDP growth and CKH HOLDINGS corporate profit expansion. As long as profit growth exceeds the rate of financing cost growth, the stock market can absorb the impact of rising interest rates. Market participants once formed a consensus Japan has finally emerged from the "Lost Decades", and the "normalization" of interest rates is a welcome signal of economic recovery. However, as long-term yields approach or even surpass sustainable nominal growth rates, the logic is undergoing a qualitative change. Atsushi Sato, General Manager of the Securities Investment Department at Fukoku Mutual Life Insurance Co., pointed out another pathway of interest rate transmission: rising rates will eventually be transmitted to enterprises in the form of higher interest expenses. He said: "It is not surprising that investors are becoming increasingly cautious about highly leveraged companies." He further added, "The future market may become more selective." This structural change is evidenced by the "fatal intersection" between Japanese bond yields and stock market dividend yields. Data shows that the dividend yield of companies in the TOPIX index is currently around 2.3%, while the yield on the 10-year Japanese government bonds has surged to over 2.75% the largest spread since the Bank of Japan's tightening policies in 2007. Hiroshi Namioka, Chief Strategist at T&D Asset Management, said: "From the perspective of dividend yield and earnings yield, bonds are gradually becoming more attractive than stocks." He added: "Once oil prices stabilize, bond purchases may increase." This "inversion of stock and bond yields" phenomenon is rare in the Japanese market over the last twenty years. In the era of zero interest rates, even with very low dividend yields, stocks still received a natural premium due to the "lack of other options effect". Now, with risk-free rates exceeding dividend yields, the logic of "stocks are better than bonds" is being systematically undermined. Dissecting the uptrend: structural fragility of index prosperity Although the Japanese stock market has seen considerable gains cumulatively this year, the "quality" of the uptrend is increasingly being questioned. Ishigane pointed out: "Since April, chip-related stocks have risen sharply, showing signs of overheating, which in turn makes the market more sensitive to the rise in interest rates." Calculations show that since the end of March, the Nikkei 225 index has been driven by the top ten contributors to about 80% of the gains including AI and semiconductor-related stocks such as SoftBank Group and Kaidex Holdings while during the bull market in January and February, this proportion was about 60%. This means that the current upward momentum of the Japanese stock market is becoming more and more concentrated and reliant on a few high-valuation growth stocks and these stocks are precisely the most sensitive to changes in interest rates. On May 15th, the Nikkei 225 index plunged by 1.99%, with AI and semiconductor stocks leading the decline. Atsushi Sato of Fukoku Mutual Life Insurance clearly stated that the upward trend in interest rates is putting direct pressure on high-valued AI-related stocks. On May 18th, the Nikkei 225 index opened lower at 61,299 points, and the decline widened to 1.5%, with semiconductor-related stocks continuing to decline, with SoftBank Group, Fujitsu falling over 2%. On May 19th, Japanese semiconductor-related and electrical wire stocks were once again subjected to concentrated selling, with profit-taking funds moving towards low-level sectors such as banks, insurance, food, and retail. It is worth noting that the impact of rising rates on different sectors is showing significant differentiation. The banking sector has been relatively resilient, with Mitsubishi UFJ Financial Group rising by over 3%, and Sumitomo Mitsui Financial Group also seeing gains the rise in rates has increased the net interest margin for banks, improving the profit prospects for financial institutions. However, this structural differentiation exposes that the "prosperity" at the index level is masking more widespread pressure on individual stocks. Mizuho Securities stock strategist Maki Sazada commented: "Investors have reacted negatively to the declines in the three major US stock indices and the rise in the 10-year Japanese government bond yield." The Nikkei 225 index fell by over 1000 points intraday on the 18th, eventually closing down by 0.96% at 60,815.95 points, with most of the 33 industries on the Tokyo Stock Exchange falling. The narrower the uptrend, and the more dependent it becomes on a few high-valuation growth stocks, the lower the market's "immunity" to rising rates. This has put the Japanese stock market into a state of "asymmetric risk": when prospects for profit are optimistic, gains are concentrated in a few stocks; but when rising rates put pressure on valuations, these stocks are the first to face the "heavy blow." Crossroads: Market optimism confronts chill At a critical juncture as rates approach 3%, there are still relatively optimistic voices in the market. Sohei Takeuchi, Senior Fund Manager at Mitsui Sumitomo DS Asset Management, believes that as Japan enters a phase of nominal economic expansion under inflationary pressures, stocks may still remain attractive. He judges that unless Japanese government bond yields rise to levels similar to US Treasury bonds (i.e. still with a difference of over 200 basis points), a large-scale shift of funds from stocks to bonds is unlikely to occur. Hiroshi Watanabe, Director of Financial Market Research at Sony Financial Group, also stated that there will not be a large-scale pullback in the Japanese stock market in the short term, because "it takes time for rising rates to negatively impact the macroeconomy and corporate profits." The core logic of these views is that rapid nominal GDP growth 4.2% for the fiscal year 2025 can still offset the pressure of rising interest rates on corporate profits in the short term. Several AI-related companies, including Kaidex Holdings, have recently demonstrated their strong fundamentals through profit improvements. However, this judgment is based on two key assumptions: one, that the nominal GDP growth rate can sustainably exceed long-term interest rates, and two, that the rate of rise in interest rates is slow enough to give companies time to adjust their balance sheets. Both assumptions are currently facing challenges. On one hand, the speed of rate hikes has far exceeded expectations not even a year ago, the Bank of Japan's internal forecasts projected that yields would only drift to around 1.32% by March 2026, while the current rate is 2.8% - more than double the internal forecast. On the other hand, persistently high oil prices are putting continued cost pressure on Japan as a net importer, and the uncertainty of the war process is amplifying the pressure for fiscal expansion both of which push the "race" between nominal growth and rates into a white-hot phase. In fact, if the judgment that "rising long-term rates take time to have a negative impact" is correct, it means that even though the current market has not fully priced in this risk, the risk does not cease to exist it is on the way, and the pace of progress may be faster than the market anticipates.