Oxford Economics believes the recent surge in Japanese government bond (JGB) yields has gone too far, too fast. The 40-year rate recently breached 4%, a high not seen since its 2007 debut. Strategists expect a consolidation in Q1 but maintain a forecast for higher yields by year-end.

The selloff was largely driven by foreign investors adding short positions, reacting to Prime Minister Sanae Takaichi's tax suspension pledge. This move threatens Japan's fragile fiscal position, and local buyers remain absent despite higher yields, opting instead for foreign securities. The firm is shifting its JGB stance to neutral.

The core issue remains policy inconsistency. If the Bank of Japan stays behind the curve, term premia will rise, worsening the fiscal outlook and weakening the yen. Markets expect more decisive action, but Oxford Economics forecasts only a single rate hike to 1% by mid-2026, suggesting sustained pressure on the bond market.