This Is Now the World's Most Volatile Bond Market

Tomohiro Ohsumi | Bloomberg | Getty Images

In addition to a sliding yen and soaring stock market, Japan's radical monetary policies are having one more side effect that policymakers may not have bargained for: they've created the most volatile government bond market in the world, analysts say.

Yields on benchmark 10-year Japanese government bonds (JGBs) on Tuesday hit 0.825 percent, their highest level since January.

In fact, JGB yields have spiked 26 basis points since Thursday as the yen weakened decisively through the 100 mark against the dollar, encouraging investors to dump bonds for stocks. A rise in U.S. Treasury yields amid brighter economic data has also encouraged the sell-off in JGBs.

(Read More: Better US Economy Throws Wrench in Currency Markets)

Since the Bank of Japan (BOJ) unveiled its radical monetary stimulus program in April to kick start a moribund economy and meet a 2 percent inflation target, the JGB market has been characterized by volatility as investors try to asses just what the unprecedented stimulus means for the world's second biggest bond market.

"In absolute terms, we are looking at 0.8 percent on the 10-year yield but if you look at it proportionately, the moves are significant," said Andre de Silva, head of Asia-Pacific Rates at HSBC in Hong Kong.

"We are looking at the most volatile bond market in the world and if you put that into context on April 4 when the BOJ announced its policies, yields were half the levels they are now. So we've seen a doubling of yield levels and that is quite alarming," he told CNBC Asia's Cash Flow.

The move in JGBs has not gone unnoticed by policymakers in Tokyo. Japan's Economics Minister Akira Amari was reported saying on Tuesday that the government and BOJ would continue to make an effort to reduce volatility in the JGB market.

The concern for the government, and some analysts, is that a rapid rise in bond yields would affect the interest payments on Japan's debt. Japan's government debt is estimated to reach 245 percent of gross domestic product this year - the highest in the world.

(Read More: Risk of Bond Market Revolt in Japan: Expert)

Watching From the Sidelines

"Central banks don't like volatility and wants everyone to understand that they are paying attention to the market," said Tim Condon, head of research for Asia and ING Financial Markets in Singapore. "The bond market is unlikely to crash but yields are likely to head higher."

The BOJ has said that it will buy $76 billion worth of government bonds every month in a bid to reflate the Japanese economy. And that massive buying should cap how far bond yields climb, strategist said.

(Read More: Why Weak Yen Remains Wild Card for Japan's Growth)

"It's difficult to go against the tide," said HSBC's de Silva. "There are lots of similarities with the Fed [U.S. Federal Reserve]. You don't fight the Fed and you don't budge the BOJ," he said referring to the Fed's quantitative easing program.

"In the bigger scheme of things yields are not going to be rising 100-200 basis points from current levels, it's just we're getting excited about the short-term volatility," de Silva said.

Condon at ING said a gradual rise in JGBs would be positive in the sense that they would indicate Japan's economy it getting back on track.

"Eventually the reflation policies will work and we will have a healthier Japanese economy. If you have bond yields hugging rates near zero that's a mark of an unhealthy economy," he said.

— By CNBC.Com's Dhara Ranasinghe; Follow her on Twitter: @DharaCNBC