Rising Japanese bond yields and the weak yen are causing some market consternation as politics and fiscal policy are back in the driver's seat. Initially, Prime Minister Sanae Takaichi dissolved parliament and set a February 8 general election, catching markets off guard, especially with her pledge to scrap a consumption tax on food for two years. The election has delivered a decisive victory for the Liberal Democratic Party under Prime Minister Takaichi, with the ruling bloc securing well above the “absolute stable majority” threshold of 261 seats and exceeding a two-thirds majority in the Lower House. However, there are still questions about the direction of fiscal policy, and longer-dated bond yields have spiked higher.

The rise in yields was large enough that the Bank of Japan commented on the speed of the selloff and suggested it's prepared to step in if trading becomes disorderly, even as it continues to move policy away from ultra-easy settings.

Let's put the recent moves in a better context. Japan's fiscal picture is improving as the economy moves past deflation and nominal growth picks up. Higher nominal gross domestic product (GDP) has translated into stronger tax revenues and a healthier fiscal balance, and the debt-to-GDP ratio has already started to edge lower. If we compare Japan's budget deficit to GDP, it stacks out better than the U.S., France, Italy and Germany—this represents a complete reversal from 15 years ago where it stood as the worst in the group.

It also helps to look at the broader public-sector balance sheet: because the Bank of Japan holds a large share of outstanding long-term JGBs, the headline debt numbers can make the near-term financing situation look worse than it really is.

Figure 1: Budget Balance as Percentage of GDP

Also, where the bond market stress is showing up matters. The biggest swings have been in super-long bonds (20–40 years), a less liquid part of the bond market in which yields can jump even without any real change in Japan's ability to fund itself.

The rise in 10-year yields isn't only about politics or the budget—it is also being driven by Japan moving away from ultra-low rates, the return of inflation at home, and the broader level of interest rates overseas.

Election jitters may keep rates choppy, but we still see more compelling opportunities in Japanese equities.

The Japan Equities Case

U.S. earnings surged in 2025, supported by continued strength in AI-related technology sectors. Japanese earnings grew even faster. Index-level earnings per share surged late in the year, pushing Japan's cumulative earnings growth well beyond that of the U.S.

Figure 2: 2025 Forward Operating Earnings

Since December 2019, trailing earnings per share for the MSCI USA Index, the MSCI EMU Index, the MSCI Japan Index, and the MSCI United Kingdom increased, with the MSCI Japan Index leading the pack, rising by 66%, outpacing its developed international peers. Notably, during the most recent earnings season in November, Japan's index-level aggregate earnings per share (EPS) recorded a sharp 9% jump, reflecting a concentrated wave of realized earnings gains.

Figure 3: Earnings Per Share Growth, MSCI Country and Region Indexes

In contrast to U.S. earnings growth in 2025, which remained heavily concentrated among large technology and AI-linked companies such as Nvidia and the rest of the Magnificent Seven, Japan's second-quarter earnings strength was far more broad-based. Japanese companies delivered robust growth across multiple sectors, spanning traditional value areas such as utilities and materials as well as growth-oriented segments including information technology and communication services. This breadth of realized results is consistent with the pronounced late-2025 spike in Japan's trailing index-level EPS.

Will Japan's rising bond yields pressure equity market valuations?

The equity risk premium that compares earnings yields to inflation-adjusted bond yields is our preferred gauge for comparing stocks and bonds. The U.S. equity risk premium currently sits below 2.5%—roughly half its average level over the last 20 years due to equity market gains as well as the normalization of bond yields. The over 5% equity premium we averaged over last two decades was well above the long-term equity risk premium we've observed in historical data.

Figure 4: S&P 500 Historical Equity Risk Premium

Yes, Japanese bond yields have ticked higher. However, when comparing equity earnings yields with inflation-adjusted bond yields, Japan's equity risk premium remains more than twice that of the S&P 500. Under WisdomTree's valuation-sensitive approach, we estimate an equity risk premium closer to 7% for both the WisdomTree Japan Hedged Equity Fund (DXJ) and the WisdomTree Japan Opportunities Fund (OPPJ).

Figure 5: Equity Risk Premiums

Looking ahead, analyst estimates through 2027 point to a stronger earnings growth outlook for the WisdomTree Japan Opportunities Equity Index relative to the MSCI Japan Index and the S&P 500.

Figure 6: Forward Operating Earnings

It is rare to find a combination of relatively lower valuation ratios and even stronger upside earnings growth, a dynamic mix that creates a powerful and compelling case for the Japan "opportunity" as we see it.

Continue the Conversation

Hear directly from our thought leaders during our upcoming Office Hours on February 11 at 1 PM ET, “Japan’s Moment: Elections, Flows & Global Opportunities,” as they unpack what recent elections, market flows and global rotations could mean for Japan-focused strategies. Register here.