Could Japan’s Bond Surge Trigger Trouble for Indian Stocks?

In January 2026, the Japan bond surge jolted the international financial markets. Long-dated Japanese Government Bonds (JGB) experienced an unprecedented rise. The 40-year yield crossed 4%, while in one day, the 30-year yield increased by more than 25 basis points. These increases were caused by Japan’s Prime Minister Sanae Takaichi's recent announcement of a fiscal expansion plan, leading to concerns of an unwind of capital flow to international markets.

Indian stock markets are facing a continuous streak of selling by foreign investors, and the increased foreign selling due to the Japan bond surge is further deteriorating the Indian stock market's impact. A multitude of market risk factors are converging, declining FII flows and rising global bond yields. This white paper assesses the working mechanism, cascading impacts, and provides vital insights to Indian investors.

Why It Is Happening in Japan Now

For the past 30 years, due to the hyper-relaxed policies of the BOJ, Japan's bond market has been inactive. The BOJ has historically practiced a yield curve control policy, aiming to keep the 10-year JGB yield at 0%. This changed dramatically in late 2025 when the BOJ increased rates for the first time in 30 years to 0.75%, after 43 months of persistent core inflation over 2%.

The tide began to change in January 2026. Prime Minister Takaichi announced a snap election and promised bold fiscal stimuli: tax breaks on food, increased defence and social security spending, and a ¥17.7 trillion package. Investors were concerned about the combination of enormous new borrowings and existing record levels of debt (¥1.34 quadrillion, or over 236% of GDP).

 

 

The result was chaos. On January 20, the yield on 40-year JGBs increased to over 4% for the first time, while the 30-year JGB reached almost 3.85% – a multi-decade high – and the 10-year JGB yield increased to 2.35%. A mere $280 million of selling caused a loss of $41 billion in market capitalisation. Japanese institutions, with domestic yields rising, began to re-evaluate their overseas holdings.

The Japanese bond surge was not a unique phenomenon. It signalled the end of the “free money” era from Japan, the world’s largest creditor nation, and necessitated a repricing of risk across all asset classes.

Rising Global Bond Yields: The Contagion Channel

The shockwave of Japan’s ultra-long bond selling does not remain local. Japanese investors possess trillions in US Treasuries, European bonds, and debt from the Global South. Rising yields on JGBs make domestic bonds more attractive, leading to capital repatriation.

In the weeks following these events, yields on the US 10-year Treasury notes increased, European bonds did the same, and debt of emerging markets was pressured. The effect of this is apparent, and the yields of bonds around the world are increasing. This is making the return on riskier investments relatively less attractive.  

In the middle of February 2026, the 10-year G-Sec yield for India stayed between 6.68-6.73%. Though a surprise debt switch and the RBI’s repo rate standing steady at 5.25% provided some relief, the combination of heavy government borrowing and persistent global economic factors caused yields to remain high. This caused the spread over US Treasuries to become less, and as a result, the attractiveness of the Indian bonds to foreign investors decreased.  

Increased global bond yields also result in the US dollar and the yen being stronger, which has been squeezing the carry trades that have financed investments in the high-yield markets such as India.  

The Yen Carry Trade Unwind and Pressure on FII Flows  

For a long time, the yen carry trade has been one of the most successful strategies in the field of finance. It involves borrowing in yen at a low interest rate, converting the loan to Indian Rupees or US dollars, and then investing in equities of India or the US. This has led to the global and Japanese funds investing billions in the Indian markets.

The Japan bond surge changed everything. When JGB yields skyrocketed, coupled with an increased value of the yen, this caused consumer borrowing, and the price of a hedge for an underlying foreign currency to increase. Furthermore, with a higher demand for the yen, this created a margin call. Therefore, funds began unwinding positions, subsequently selling Indian stocks and bonds to pay yen loans.  

Guess how much this led to a massive sell-off of Indian equities? The Foreign Portfolio Investors (FPI) sold a record ₹1.66 lakh crore in Indian equities in the year 2025. Also, in the month of January 2026, the net FII (Foreign Institutional Investors) equity outflow was more than $4 billion. Once February came, there was a mix of thin buying in which the flow of the market was still on the conservative side. 

The Domestic Institutional Investors (DII) and the strong Systematic Investment Plan (SIP) inflow of ₹3.34 lakh crore in 2025, mitigated the impact and allowed the DII to, for the first time, surpass the FII in the Nifty 50 ownership.  

The threat continues. Analysts believe that a further 50–100 basis point rise in Japanese yields could accelerate the process of repatriation. Japanese institutions possess more than $1.1 trillion in foreign assets. This means that for even a slight shift in investment, due to the flow of funds, the pressure for foreign institutional investment (FII) in India intensifies.

 

 

Direct Indian Stock Market Impact So Far

The Indian stock market impact is starting to show some signs of visibility and containment. The Nifty 50 dropped by 3.1% in January 2026 due to the start of the turmoil within the JGB, where mid and small caps began correcting at an even sharper rate. In mid-February, DII buying and an optimistic outlook from the US-India trading partnership supported the index near the 25,600 to 26,000 value range.

The sectors of IT, consumer discretionary, and autos are more volatile and have foreign ownership. The real estate and FMCG sectors have been falling due to broader risk-off sentiment. Some shortage is caused by a moderation of valuations (the Nifty 50 forward P/E is near 20.5x), but the growth of earnings is still the most important factor. EPS growth of 12 to 13 percent for FY27 is projected by brokerages, but any slowdown could lead to an increase in selling.

The rupee also fell to previously record lows due to the strong dollar and yen, and FII outflows. A weaker currency increases the risk of imported inflation, and it also negatively impacts foreign investors’ returns in dollars.

Key Market Risk Factors Investors Must Monitor

Several market risk factors are currently interconnected:

- More Japanese yields- strong JGB 10-year results (between 2.5% and 3%) mean a dramatic increase in repatriation.

- Persistent increases in global bond yields- US 10-year results above 4.5% lead to greater pressure on emerging markets.

The following points need to be considered the next time FII flows reverse:

1. FII flow reversal: February showed tentative buying. Renewed selling waves can once again test the 24k-25k Nifty support levels.

2. Rupee depreciation and inflation: A further slide close to 88-90 levels against the dollar will increase import costs and will have the RBI on its toes.

3. Domestic fiscal and earnings risks: Heavy government borrowing for FY27 and muted earnings for Q4 will increase the burden.

4. Geopolitical and policy surprises: US tariffs, elections in different parts of the world, and surprises from BOJ are still wild cards.

These are all factors contributing to a high level of volatility. The India VIX is considered the level of uncertainty.

Analysis Of The Risks Of This Environment

Geopolitics still supports India’s positive outlook in this environment. Robust domestic consumption, recovering capex, and healthy corporate balance sheets strengthened the position. DIIs and retail investors showed the capacity to absorb FII selling. A record level of SIP flow provided support for demand.

For investors:

• Remain diversified: Give preferential treatment to large caps and high-quality mid caps that have strong earnings visibility.
• Prioritise the fundamentals: Banking, capital goods, and defence sectors will see themselves outperform others if the capex theme continues.
• Take advantage of volatility: SIPs and lump sum investments made during downturns will average costs and are considered phased investments.
• Think about your global cue: Monitor FII flow data, US Treasury yield prediction, and JGB auction weekly.
• Think about debt allocation: If global bond yield peaks, then shorter-duration Indian bonds and other dynamic funds could provide some headroom.

Post trade deals, a tactical adjustment towards domestic consumption and exports could also yield results.

 

 

Conclusion: There is a possibility of trouble, but it is not certain.

The rise in Japanese bonds has certainly given a new dimension to market risk factors, in this case, Indian equities. We may see high global bond yields, pressure on FII flows, and an unwinding of the Japan carry trade. This may increase the volatility and the impact of the Indian stock markets in the short term.

However, India is not in the same position it was in 2013 or 2022. Strong domestic institutional ownership, coupled with good GDP growth in the forecast range of 6.9-7.3% by the year 2026, and moderating valuations, provides a safety net. The Japanese bond surge indicates global liquidity is still of importance, but India’s domestic drivers are showing more strength than ever.

Disciplined investors focusing on quality and avoiding leverage will have the best opportunities for this episode.

(Source: live mint)

DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.