Investors have begun to show cautious interest in Japanese government bonds (JGBs) after yields on the 10-year bonds climbed above 2.5 percent for the first time this century, driven by rising interest rates, expansive fiscal stimulus, and inflation concerns. This yield increase represents a 1.6 percentage point jump since the start of last year, marking Japan as the world’s weakest major bond market during that period, as bond prices fall when yields rise.

Despite the rising yields attracting some buyers, many asset managers remain hesitant to commit large positions, reflecting lingering concerns about the country’s fiscal outlook, high energy costs, and government spending plans. Allianz Global Investors’ senior portfolio manager Ranjiv Mann noted the firm had recently purchased modest amounts of 20-year JGBs but would require clearer hawkish signals from the Bank of Japan (BoJ) before expanding its exposure.

JGBs have long been considered a challenging asset class for international investors. For decades, attempts to short these bonds—betting on rising yields—resulted in significant losses due to Japan’s prolonged period of negative interest rates and the BoJ’s yield curve control policy, which sought to keep 10-year yields near zero. Now, some market participants fear the opposite risk: that a surge in buying could be undone if inflation expectations rise and the BoJ delays tightening monetary policy amid Prime Minister Sanae Takaichi’s $2 trillion fiscal program.

April LaRusse, head of fixed-income specialists at Insight Investment, commented on the reluctance of investors to be early movers, citing the historical difficulties of the JGB trade. The bonds have experienced a small price rebound recently after Japan’s finance minister appealed to domestic pension funds and retail investors to increase purchases of government debt. However, skepticism remains about whether significant repatriation of capital will materialize.

Market watchers are closely observing moves by the Government Pension Investment Fund (GPIF), Japan’s $1.8 trillion public pension fund, which is among the world’s largest institutional investors. While the GPIF is unlikely to alter its long-term asset allocation until its next scheduled review in 2030, analysts note that within its day-to-day management bands, the fund could increase its holdings of domestic bonds, potentially bringing an estimated ¥12 trillion ($75 billion) in new inflows. This could encourage smaller managers to follow suit.

Some strategists, such as Jordan Rochester of Mizuho Bank, emphasize the importance of adjusting positions in line with GPIF’s moves. However, others like Fidelity’s Terrence Pang highlight the GPIF’s historical independence and its stated policy to avoid using its assets for market intervention or economic policy implementation.

Recent government debt auctions have shown relatively strong demand, interpreted by some as evidence of renewed interest from large institutional investors, including those abroad. Masayuki Nakajima, senior strategist at Mizuho, pointed to two auctions of 20- and 30-year bonds earlier this month as illustrative of this trend.

Nonetheless, many international managers remain cautious. Carmignac’s investment committee member Kevin Thozet said the firm had increased exposure to long-dated JGBs modestly but remains concerned about volatility driven by fluctuating oil prices, fiscal stimulus, and planned tax cuts. He indicated that greater fiscal prudence from the government would be necessary before committing more significantly.

Concerns persist about the sustainability of Japan’s fiscal policy given its debt-to-GDP ratio hovering around 200 percent. While the BoJ continues its bond purchases, it has reduced the pace compared to previous years. DoubleLine portfolio manager Bill Campbell expressed reluctance to counter the ongoing sell-off, noting that a fundamental shift addressing Japan’s fiscal and debt challenges would be required before he felt comfortable increasing holdings.

Overall, while higher yields have attracted tentative interest, uncertainty about government spending, inflation, and the BoJ’s policy stance continues to restrain large-scale investment in Japanese government bonds.