The selloff in French bonds is intensifying, with the 10-year French government bond yield briefly approaching 5%, the highest level since 2002, and borrowing costs now exceeding those of Greece and Italy.

At the same time, US Treasury yields have climbed to a multi-decade high of 5.28%, and even softer inflation data has failed to halt the selling.

Behind both storms, there may be a Japanese shadow.

Bloomberg columnist Gearoid Reidy argued in an October 9 article:

Two years ago, when Japan embarked on the path of policy normalization, people asked whether Japan was ready for a "world with interest rates." Perhaps what we should have asked was: is the world ready for a "Japan with interest rates"?

He believes France may only be the first victim.

Data shows that as of July, Japanese investors held about 23 trillion yen ($145 billion) in French government bonds, the largest overweight position in the euro area.

But the Japanese 10-year government bond yield rose above 3% last month, a 30-year high. After currency hedging, the yield advantage of French 10-year government bonds over Japanese government bonds has narrowed to only about 40 basis points.

With the yield advantage disappearing and France's fiscal position deteriorating, Japanese funds are beginning to loosen.

Japanese holdings of French bonds have fallen 2.5% since the end of last year. A fund under the global fixed income team led by Shinji Kunibe at Sumitomo Mitsui DS Asset Management has already liquidated its French bond holdings due to fiscal concerns. Masayuki Nakajima of Mizuho said: "Even if valuations look cheaper, Japanese investors' incentive to rebuild positions is declining."

US Treasuries: How Long Can Political Cover Last?

Reidy's analysis then turned to the United States.

In the first half of this year, Japanese local investors sold a net 4.45 trillion yen (about $28 billion) of US long-term government bonds, the first half-year net sale since 2022.

Reidy acknowledges that a large-scale Japanese selloff of US Treasuries is unlikely — Tokyo's dependence on Washington for security guarantees constitutes a political reality. But he points out that Japan does not need to "sell" for US borrowing costs to rise; "just buying less is enough."

At the same time, Wall Street is divided over the specific mechanism by which Japan affects US Treasuries.

Ed Yardeni, president and chief investment strategist at Yardeni Research, believes the unwinding of the yen carry trade is the driver. He notes that as the Bank of Japan raises rates, carry traders are forced to sell government bonds of various countries that they had previously bought with cheap yen loans. "This trade allowed many governments to run fiscal deficits without pushing up bond yields. Now it is time to pay the debt." He characterizes the current situation as the revenge of the "bond vigilantes."

Shoki Omori, chief Japan fixed income strategist at Deutsche Bank, questions this. He argues that carry unwinds leave a fixed market "fingerprint": the yen jumps, stocks fall, and US Treasuries rise on safe-haven demand.

But current price action shows completely opposite characteristics... Bonds and the yen are falling together, a signal of inflation and rate repricing, not deleveraging.

The two sides clearly disagree, but there is only one point of consensus: the root cause points to the Japanese bond market.

Japanese Funds Are "Coming Home"

Reidy's core judgment is that Japanese funds are not withdrawing from the world, but becoming more selective.

According to estimates by the Dai-ichi Life Research Institute, Japan's Government Pension Investment Fund (GPIF) bought 5.7 trillion yen of Japanese government bonds in the second quarter, more than double the average level for the same period over the past five years. Public pensions overall bought 6.8 trillion yen, and banks and insurance companies have also been net buyers of Japanese government bonds in recent months.

A shift is also appearing at the retail level. Subscriptions for Japanese retail government bonds exceeded 1 trillion yen for the first time in July 2026 and have remained at that level for several consecutive months — the first time since the current sales model began in 2014.

Reidy wrote:

Japan is rebuilding an entire domestic fixed income culture that had almost disappeared during decades of zero or negative interest rates.

It is worth noting that Japanese investors have not withdrawn from overseas markets across the board. According to Bloomberg, in the first half of this year they remained net buyers of German, Italian and UK government bonds, and demand for overseas equities also remained strong. Reidy's judgment is that Japanese capital has become more selective, not fully retreating.

France's Own Problems

Of course, the retreat of Japanese funds is only the trigger; France's own fiscal difficulties are the root cause.

The spread between French and German 10-year government bonds widened by 32 basis points last week to 141 basis points. According to Bloomberg, Jim Reid of Deutsche Bank said this was the largest weekly widening since Bloomberg data began in 1990, covering German reunification, the European debt crisis and the COVID-19 pandemic.

Bank of France Governor Emmanuel Moulin warned that if France does not fix its public finances, it may be "gradually strangled" by rising interest rates.

French debt is already close to 120% of GDP, and the deficit has exceeded 5% for three consecutive years. Kevin Thozet, portfolio adviser at French asset manager Carmignac, said:

For years, even decades, France has been a free rider in Europe. As long as no one noticed, it worked. Now people are starting to notice.

Supply-side pressure is equally severe. France's debt management office (AFT) plans to issue 340 billion euros of government bonds in 2027, a record scale. Goldman Sachs expects France's net duration supply in 2027 to be about 25% higher than this year, tied with Germany for the largest increase in the euro area.

Antonio Del Favero of Macro Hive worries about chain reactions: "If Japan is seen as cutting its overweight because France is no longer a 'clean core allocation,' benchmark investors in the US, Asia and parts of Europe may also reassess."

Hideo Shimomura of Fivestar Asset Management was more direct:

This is just the beginning. If the European Central Bank stands by, based on the experience of the European debt crisis, the French 10-year government bond yield could rise to 7%.

Japan Itself: Buffers, But Not Invulnerable

Reidy also points out that Japan is not immune to this new landscape.

But Japan has several buffers: relatively stable politics, a well-funded pension system, and more importantly, time. As of the end of March this year, the average coupon on Japanese government debt was slightly below 1%, with an average maturity of nearly 10 years, meaning the fiscal impact of rising rates will be gradual.

Still, Prime Minister Sanae Takaichi has expressed dissatisfaction with recent rate hikes and plans to replace several Bank of Japan board members with more dovish candidates. Reidy notes that her language in this week's parliamentary opening speech was noticeably more cautious, with emphasis on reassuring the market.

Reidy's conclusion is:

Japanese funds have not retreated from the world. But after being taken for granted for decades, the world must now compete with Japan's domestic market to win this capital.

He ended with an analogy: "Discerning Japanese consumers have long been willing to pay a premium for luxury goods such as French handbags. Now French bonds — and everyone else's bonds — must offer them a premium in return."