Chapter 1 1.4

The JGB Yield Curve

Understanding the JGB yield curve - what it is, why it matters, and how to interpret it

A yield curve is a simple graph that plots the yield (YTM) of bonds against their maturity (time to "expire").

  • X-Axis (Horizontal): Shows the time to maturity (e.g., 2-year, 5-year, 10-year, 30-year).
  • Y-Axis (Vertical): Shows the yield-to-maturity for each of those bonds.

For JGBs, the curve typically covers the following maturities:

  • Short-term: 2-year, 5-year
  • Medium-term: 7-year, 10-year
  • Long-term: 20-year, 30-year, 40-year

Why Plot a Curve?

The yield curve condenses an enormous amount of market information into a single snapshot:

  • What investors think about short-term policy (Bank of Japan's next moves)
  • What investors expect for inflation over the next decade
  • How much risk premium they demand for lending to the government for 30+ years
  • Signals about economic growth and recession risk

Different Shapes of the Yield Curve

The slope and shape of the yield curve tell us what the bond market thinks is coming. There are three primary shapes:

1. Normal (Upward-Sloping) Curve

What it looks like: Yields increase as maturity increases (e.g., 2yr = 0.5%, 10yr = 1.5%, 30yr = 2.5%)

What it generally indicates:

  • Markets expect stable or growing economy
  • Inflation expected to remain moderate or increase slightly
  • BOJ unlikely to cut rates aggressively
  • Investors demand higher compensation (term premium) for longer maturities

2. Inverted (Downward-Sloping) Curve

What it looks like: Short-term yields higher than long-term yields (e.g., 2yr = 2.0%, 10yr = 1.5%, 30yr = 1.2%)

What it generally indicates:

  • Recession warning: The market expects the BOJ to cut rates in the future due to economic weakness
  • Near-term inflation concerns, but deflation/low growth expected long-term
  • Historically one of the most reliable recession indicators (though less common in Japan due to persistent deflation)

3. Flat Curve

What it looks like: All yields roughly the same (e.g., 2yr = 1.0%, 10yr = 1.1%, 30yr = 1.2%)

What it generally indicates:

  • Uncertainty about the future: Markets can't agree on direction
  • Transition period between economic regimes
  • Can signal a pause before either inversion or steepening
  • In Japan's case (2016-March 2024), artificial flattening due to BOJ's Yield Curve Control
Note: These shapes and their interpretations are simply the default rules of thumb. The meaning of a particular yield curve shape can vary significantly depending on the country, time period, and market environment—even if the curve looks similar. Always consider the broader context when analyzing yield curves.

References

  1. Bank of Japan. "Yield Curve Control." Available at: https://www.boj.or.jp/en/mopo/outline/qqe.htm.
  2. Japan Ministry of Finance. "JGB Interest Rate Data." Available at: https://www.mof.go.jp/english/policy/jgbs/reference/interest_rate/index.htm.