As more and more people expect the Bank of Japan will have to take further austerity measures in the coming months as inflation continues to rage. Japan's 10-year treasury yield rose above the 1% critical psychological level on Wednesday, the first time since the Bank of Japan increased its unprecedented stimulus measures in 2013. This is significant for the market because this benchmark yield was once a reference point for the Bank of Japan's yield curve control policy.

Recently, the yield on 20-year and 30-year Japanese treasury bonds has also reached the highest point in ten years. The inflation rate has been higher than the Bank of Japan's 2% target for two years. Analysts believe that Japan's inflation rate may rise further.

The focus now is on how fast Japan's ultra-loose monetary policy will be adjusted, and how much the yield will rise further.

Shoki Omori, chief strategist at Mizuho Securities, said, “If interest rate hikes are expected to heat up, then the yield on Japanese treasury bonds on the entire curve, especially the 10-year treasury bond yield, will rise even more.” He said that in the next few weeks, the 10-year Japanese government bond yield could reach 1.2%.

The price of the swap market is that the possibility that the Bank of Japan will raise interest rates again at the end of July meeting is about 60%, while at the time of the Bank of Japan's historic March policy decision, this possibility was only 14%.

Goldman Sachs Group strategists predict that Japan's 10-year treasury yield will rise to 2% by the end of 2026, as people expect the Bank of Japan to implement an “extended” austerity cycle.

Outsiders are speculating that the Bank of Japan may raise interest rates again to stop the yen from falling further. However, despite rising yields on Japanese treasury bonds, the yen remained weak.

Shusuke Yamada, head of Japanese exchange rate and interest rate strategy at Bank of America Securities Japan, said that the yield gap between the US and Japan is still huge, especially short-term notes. Short-term notes are used for arbitrage transactions. Arbitrage trading refers to borrowing money cheaply from one country and then investing in higher-yielding assets in another country.

He said that the interest rate spread between the US and Japan is still above 5% in the short term. This is the target of arbitrage. The yen will not strengthen as the yield gap narrows a little; on the contrary, the reduction in market volatility will make arbitrage trading more attractive to investors. In fact, according to Yamada, the undervalued valuation of the yen will only work if the short-term spread between the US and Japan falls below at least 3%. For example, if interest spreads stop falling after falling to 4%, it will be difficult to correct the depreciation of the yen.

Tom Kenny, a senior international economist at the Bank of Australia and New Zealand Group, wrote in a report that the Bank of Japan may raise interest rates at the next policy meeting and may also adopt quantitative austerity measures to reduce some of its accumulated assets. Kenny wrote that recent statements by senior Bank of Japan officials showed that they had “little tolerance” for the upward risk of inflation.

The Bank of Japan reduced the number of debt purchases during regular operations on May 13, leading people to speculate that it will begin to reduce the amount of Japanese treasury bonds purchased each month. Japanese treasury yields are also under upward pressure as a result. The next operation is scheduled for this Thursday.

Keiko Onogi, senior Japanese treasury bond strategist at Daiwa Securities Co (Daiwa Securities Co), said: “After the Bank of Japan reduced the scale of debt purchases on May 13, people are worried that the yield will continue to rise above 1%.”

In short, the Bank of Japan found itself in a dilemma: on the one hand, it faced soaring inflation and was forced to tighten monetary policy to support and push up the Japanese yen's continuous internal rebellion; but on the other hand, as the Bank of Japan ceased to act as the “first buyer,” “last buyer,” and “any other buyer,” these tightening policies continued to push up Japan's treasury bond yields.

The next BOJ policy meeting will be held on June 13-14.