Recently, I've noticed an interesting phenomenon in the Japanese bond market.

Many traders are betting that the Bank of Japan will continue to raise interest rates in December, and the reasoning sounds pretty solid—the yield on Japan's two-year government bonds has surpassed 1%. What does that mean? It's the first time since the 2008 financial crisis. The market logic is simple: as central banks around the world tighten monetary policy, the Bank of Japan under Kazuo Ueda is expected to follow suit.

But there’s an easily overlooked point here.

Japan’s inflation problem is far from being resolved. Although interest rates are rising, compared with other major economies, the level is still low. The more crucial issue is: to what extent does Japan’s neutral interest rate need to be raised to truly anchor inflation expectations? Right now, the market is generally underestimating this question.

The global head of rates at Vanguard recently made a pretty direct statement—they recommend underweighting Japanese government bonds. The reason is clear: the Bank of Japan’s rate-hiking cycle may not be over yet, and December could be another key inflection point.

From a risk-reward perspective, chasing Japanese government bonds at these levels is not the optimal choice. When market expectations and central bank actions diverge, that’s often when volatility spikes. The story of Japan’s interest rate adjustment cycle may still have another chapter to unfold.