Chapter 1 1.5

Reading the JGB Yield Curve

How to interpret different shapes of the yield curve and what they signal about the economy

The JGB yield curve is a vital dashboard for Japan's economy. Different parts of the curve reveal different information about market expectations, central bank policy, and economic conditions. This is partly the reason why banks typically have a minimum of three traders focused on different segments of the curve and the drawn out yield curve can also be considered a simple, weighted average representation of such expectations.

Short-Term (≤5Y)
Long-Term (5-10Y)
Super-Long (>10Y)

Market Segmentation

Each segment is driven by different market factors and monitored by specialized trading desks:

Segment Maturities Primary Driver Key Sensitivity
Short-Term T-bills, 2Y, 5Y BOJ policy rate expectations BOJ statements, inflation data, wage growth
Long-Term 5Y, 7Y, 10Y Medium-term inflation and growth expectations 10Y benchmark balances policy expectations and structural outlook
Super-Long 20Y, 30Y, 40Y Fiscal sustainability and debt management Debt issuance plans, pension demand, demographics

Example: The 2yr-30yr Spread (November 2025)

Let's examine the recent JGB yield curve to see what the market is telling us. This is a high-level overview of how traders analyze curve movements in real-time.

Current Market Data

Maturity Yield (November 2025) Change from YCC Era (2023)
2-year ~0.95% +0.85% (was ~0.10%)
5-year ~1.25% +1.00% (was ~0.25%)
10-year ~1.66% +1.16% (was ~0.50%)
20-year ~2.54% +1.64% (was ~0.90%)
30-year ~3.07% +2.07% (was ~1.00%)
40-year ~3.25% +2.15% (was ~1.10%)

Key Observation: 2yr-30yr Spread

Spread Calculation: 30yr (3.07%) - 2yr (0.95%) = 2.12 percentage points

This is one of the steepest curves Japan has ever seen

What This Could Be Telling Us

1. Steep Curve = Growth Expectations

While a steep yield curve can symbolize market expectations for higher inflation and growth over the long term compared to the near term, the primary concern at the moment (November 2025) is actually related to Japan's fiscal outlook. The sharp steepening—especially at the super-long end—reflects heightened market anxiety over increased government expenditures and fiscal sustainability under the new Takaichi administration.

  • Why it matters: After 30 years of deflation, this could have represented a historic shift in market psychology, but in the current environment, fiscal concerns are dominant
  • Historical context: During the YCC era (2016-2023), this spread was often below 1%
  • Current context: Investors are demanding higher yields for long-dated JGBs due to worries about future debt issuance and fiscal management

2. Short-Term Segment Reflects BOJ Policy Path

The 2-year yield around 0.95% suggests the market expects the BOJ to gradually raise its policy rate over the next 1-2 years.

  • What changed: In 2023, markets expected the BOJ to stay near zero indefinitely
  • Key catalysts: Wage growth (2024 Shunto saw 5%+ raises), core inflation above 2% target

3. Super-Long Segment Reflects Fiscal Expectations

The 30-year and 40-year yields above 3% reflect concerns about Japan's long-term fiscal sustainability and debt management.

  • What it means: Investors demand higher compensation for holding multi-decade Japanese debt
  • Key drivers: Government debt issuance plans, aging demographics, fiscal policy expectations

📌 Key Drivers Change Dynamically

The factors driving each segment of the curve are not fixed—they shift depending on the market environment:

  • Normal times: Short-term rates follow BOJ policy, long-term rates follow growth/inflation expectations
  • Crisis times: All maturities may move together as investors flee to or from JGBs as a safe haven
  • Fiscal stress: The super-long end (30yr, 40yr) can decouple and rise sharply on debt sustainability fears
  • Policy regime changes: When the BOJ ended YCC in 2024, the entire curve repriced as artificial caps were removed

Bottom line: Always ask "What is the market worried about right now?" to understand which drivers are dominant.

Common Curve Misinterpretations

❌ Mistake #1: "Steep curve means the BOJ will hike rates aggressively"

Reality: A steep curve often means the market expects gradual hikes at the front end but structural inflation at the long end. The steepness comes from diverging expectations, not aggressive tightening.

❌ Mistake #2: "Rising long-end yields always mean fiscal crisis"

Reality: Rising yields can reflect positive developments (growth, end of deflation, normalization) rather than panic. Context matters—look at credit spreads, FX moves, and equity markets together.

❌ Mistake #3: "The curve predicts the future"

Reality: The curve reflects current market consensus, which is often wrong. It's a probability-weighted view, not a forecast. Use it to understand market sentiment, not as gospel.

A Thought Experiment

Before we look at who influences the curve, it's worth thinking about what determines yields at different maturities from a fundamental perspective. We touched on this above.

A thought experiment: Imagine you have ¥1,000,000 to lend. Would you charge the same interest rate for lending it overnight versus lending it for 30 years? Of course not. Here's why longer-term lending demands higher yields:

  • Inflation Risk: Inflation over 30 years is much harder to predict than over 1 year. You need compensation for this uncertainty
  • Opportunity Cost: Locking up money for 30 years means missing out on other investment opportunities that might arise
  • Interest Rate Risk: If market rates rise tomorrow, you're stuck earning the old, lower rate for decades
  • Liquidity: Short-term bonds are easier to sell quickly without affecting the price

This intuition explains why yield curves are typically upward-sloping—longer maturities compensate for these additional risks. This extra yield is called the term premium.

📌 Term Premium vs Risk Premium

  • Term Premium: The extra yield demanded for lending for a longer time period (time risk)
  • Risk Premium: The extra yield demanded for lending to a riskier borrower (credit risk)
  • Example: A 30-year JGB yields 3.07% while a 2-year yields 0.95%. The ~2.12% difference is the term premium. If a corporation borrows at 4.0% for 30 years, the additional ~0.93% above JGB is the risk premium.

The Bank of Japan’s Influence

Although we will get into more detail in later chapters, this topic is worth mentioning now. While market forces determine the live shape of the curve, the Bank of Japan has extraordinary power to influence the JGB yield curve through it's monetary policy. Understanding this is essential for JGB investors.

How the BOJ shapes the curve:

  • Short End (2-year and below): The BOJ sets the overnight policy rate, which directly anchors short-term yields. The BOJ raised policy rates from -0.1% (pre-March 2024) to 0-0.1% (March 2024), then to 0.25% (July 2024), and to 0.50% (January 2025), causing 2-year yields to follow upward.
  • Long End (10-year and beyond): From 2016-2024, the BOJ implemented Yield Curve Control (YCC), directly targeting the 10-year yield at around 0%. The BOJ committed to unlimited bond purchases to defend this target, effectively controlling long-term yields. After abandoning YCC in March 2024, the 10-year yield rose from 0% to the 1.5-1.7% range as the market regained control.
  • Overall Curve Pressure: Through Quantitative Easing (QE), the BOJ purchases JGBs across all maturities. These large-scale purchases create artificial demand, pushing yields down and compressing term premiums. As of 2024-2025, the BOJ is gradually tapering these purchases, allowing the curve to normalize.
  • Dominant Secondary Market Participant: The BOJ holds an estimated ¥560 trillion in JGBs, representing approximately 45-50% of all outstanding JGBs. This makes the BOJ not just a policy setter but the largest investor in the secondary market. This concentrated ownership continues to influence market liquidity, price discovery, and trading dynamics even as the BOJ gradually reduces its balance sheet.

📌 Further Reading

For a detailed history of the BOJ's policies—from ZIRP to QE to YCC and the recent normalization—see Chapter 2.12: History of Japan's Monetary Policy.

Modeling the Yield Curve

You may have wondered why the yield curve charts show such a smooth, continuous line when it represents different concepts or expectations—and in reality, we only have discrete data points (2yr, 5yr, 10yr, etc.). How do we estimate yields for maturities between these points, like a 7.5-year bond?

This is where yield curve modeling comes in. Different market participants use different approaches depending on their needs:

Common Modeling Approaches

Model Type Used By Purpose
Nelson-Siegel-Svensson (NSS) Ministry of Finance, Central Banks Official benchmark curves for policy and reporting. Balances accuracy with stability—captures level, slope, and curvature while avoiding unrealistic shapes.
Cubic Splines Academic researchers Highly flexible fitting that passes through all data points. Can produce unstable results but useful for historical analysis.
Proprietary Models Hedge funds, Traders Custom approaches that incorporate market microstructure, liquidity premiums, and arbitrage opportunities not captured by standard models.
Linear Interpolation Quick estimates Simple straight-line connection between points. Fast but misses important curve features like humps or curvature.

Why Different Models Matter

The choice of model isn't just academic—it affects real-world pricing:

  • Bond Valuation: A bond with 7.5 years to maturity needs a yield estimate between the 5-year and 10-year points
  • Risk Management: Portfolio duration calculations require yields at all maturities
  • Derivatives Pricing: Swaps and options depend on accurate yield curve interpolation

Key Insight: Official data from the MOF uses NSS modeling, which provides stable, policy-oriented curves. However, traders often observe that actual market prices deviate from these fitted curves due to supply/demand imbalances, liquidity differences, and special factors. These deviations create arbitrage opportunities.

You can download the comprehensive raw historical data for all JGB yields directly from the MOF:

References

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