Japanese bond market functioning remains subdued, yields seen rising

The Bank of Japan's latest Bond Market Survey for February 2026 indicates that market participants perceive bond market functioning as subdued, with little improvement over the past three months. Respondents also forecast a gradual increase in Japanese government bond yields across all maturities through early 2028.

Market functioning remains subdued

The February 2026 Bond Market Survey reveals that market participants continue to assess the overall functioning of the Japanese government bond (JGB) secondary market as subdued.

A significant 68 percent of respondents described functioning as 'not very high,' while 28 percent rated it as 'low,' resulting in a Diffusion Index (DI) of -26. This represents only a slight improvement from the -24 DI three months prior.

Factors contributing to this perception include a wide bid-ask spread (DI -31), small order quantities (DI -38), and not very high dealing frequency (DI -10).

Furthermore, 87 percent indicated that market functioning 'hasn't really improved' over the last three months, with only 3 percent reporting a decrease.

The ability to execute dealings with expected prices and lots also remains limited, with only 26 percent and 31 percent of respondents, respectively, indicating 'yes' for the current situation.

Yields expected to climb gradually

Looking ahead, market participants anticipate a gradual upward trend in newly issued JGB yields across all maturities.

The median forecast for the 10-year JGB yield is projected to rise from 2.30 percent at end-March 2026 to 2.50 percent by end-March 2028.

Similarly, the 2-year JGB yield is expected to increase from a median of 1.30 percent to 1.70 percent over the same period.

Longer-dated bonds also show a consistent upward trajectory, with the 30-year JGB yield's median forecast moving from 3.60 percent to 3.70 percent by March 2028.

The probability distribution forecast for the 10-year JGB yield at end-March 2028 shows a higher concentration in the 2.51-2.75 percent range (26.9 percent) compared to end-March 2027 (19.3 percent), indicating a shift towards higher yield expectations over time.

A quiet warning from the market

The survey confirms persistent challenges in JGB market liquidity, suggesting the Bank of Japan's ultra-loose policy strains market functioning.

Forecasts for rising yields, though modest, reflect a growing consensus that the era of extremely low rates is nearing its end.

This combination of subdued market health and a slow upward yield trajectory presents a subtle, yet significant, signal for future monetary policy adjustments.