Why could the unrest surrounding the new Japanese government spill over into U.S. financial markets? – Agence France-Presse/Getty Images
Recent developments overseas could complicate the White House’s agenda of lower borrowing costs, while also intensifying competition for investors in the U.S. and Japanese bond markets.
Aggressive fiscal stimulus efforts by the office of Japan’s first female Prime Minister, Sanae Takaichi, have created a rise in long-term Japanese government bond yields and further weakness in the yen USDJPY in recent weeks. This is a situation that is being compared to that of September-October 2022 in the UK, which resulted from a crisis of confidence following a package of unfunded tax cuts proposed by the government of then Prime Minister Liz Truss.
Read: Liz Truss redux? Simultaneous collapse of Japanese currency and bonds draws strange parallels
The United States must manage the cost of paying interest given a national debt of more than $38 trillion, and that’s a key reason the Trump administration wants to drive down long-term Treasury yields. Last week, Treasury Secretary Scott Bessent said in a speech in New York that the United States was making substantial progress in keeping most market interest rates low. He also said the 10-year “term premium,” or additional compensation investors demand for holding long-term maturities, was fundamentally unchanged. Longer-term yields are important because they set the borrowing rates used by U.S. households, businesses and the government.
Developments in Japan now create the risk that U.S. yields will rise alongside those in Japan. This week, Japanese government bond yields rose to their highest levels in almost two decades, with the country’s 10-year yield BX:TMBMKJP-10Y surging above 1.78% to reach its highest level in more than 17 years. The 40-year yield BX:TMBMKJP-40Y hit an all-time high just above 3.7%.
In the United States, 2-BX:TMUBMUSD02Y and 10-year BX:TMUBMUSD10Y yields ended Friday’s session at three-week lows, at 3.51% and nearly 4.06% respectively. The US 30-year yield BX:TMUBMUSD30Y fell to 4.71%, its lowest level since November 13.
There is now a risk that U.S. yields may not fall as much as they otherwise would after factoring in market-implied expectations for a series of interest rate cuts by the Federal Reserve through 2026.
Treasury yields won’t necessarily follow rising Japanese government bond rates “on a one-to-one basis,” but there could be a limit to how low they can go, said Adam Turnquist, chief technical strategist at LPL Financial. He added that the impact of Japanese developments on the U.S. bond market could take years to be felt, but “we worry about it now because of the direction Japanese politics is going” and the possibility that impact could occur even sooner.
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Some of the catalysts that typically tend to push Treasury yields lower, such as any comments from U.S. monetary policymakers suggesting the Fed might be inclined to cut rates, “could be muted due to the increased value of foreign debt,” Turnquist added.
U.S. government debt rebounded for a second day on Friday, pushing yields lower, after New York Fed President John Williams said it was possible to cut short-term interest rates.
The three major US stock indexes DJIA SPX COMP closed higher on Friday, but posted sharp weekly losses, as investors tried to calm doubts about the artificial intelligence trade.
The worrying rise in Japanese government bond yields has not yet been fully reflected in the US bond market, but it remains a risk. “A repeat of the Truss episode is what people are afraid of,” said Marc Chandler, chief market strategist and managing director of Bannockburn Capital Markets.
Concerns about Japan took on even greater importance on Friday, when Takaichi’s cabinet approved a 21.3 trillion yen (or about $140 billion) economic stimulus plan, which Reuters called lavish. The amount of new spending injected into the country’s economy from a supplementary budget, much of which is not reallocated from existing funds, amounts to 17.7 trillion yen ($112 billion).
Concern over Takaichi’s stimulus efforts resulted in a Japanese yen that weakened against its major peers and fell to a 10-month low ahead of Friday’s session, as well as a rise in the country’s long-term yields. Yields on 30-year Japanese government debt BX:TMBMKJP-30Y rose this month to 3.33%.
Japan is the largest foreign holder of Treasuries, with a share of about 13 percent, according to the most recent data from the U.S. Treasury Department, and the worry is that the country’s investors could one day pull the rug out from under them by keeping more of their savings at home.
Earlier in the week, weak 20-year auctions in Japan were cited as one reason why U.S. Treasury yields were slightly lower in early trading in New York, meaning demand for U.S. government securities remained in place. Global investors are often incentivized to move their money based on which country offers the highest returns and best overall value.
“The conventional wisdom is that as yields rise in Japan, Japanese are more likely to keep their savings at home rather than export them,” Chandler said. “The Japanese have been buying U.S. Treasuries and stocks, and if they decide to keep their money at home, those U.S. markets could lose their supply.”
For now, Japanese investors, including insurers and pension funds, appear to continue exporting their savings by buying more foreign government debt securities such as Treasury bills. Data from the U.S. Treasury Department shows that as of September, Japanese investors held just under $1.19 trillion in Treasuries, a figure that has increased every month this year and is up from about $1.06 trillion last December.
One of the reasons for this is the exchange rate. The yen has depreciated against almost all major currencies this year. Japanese investors buy U.S. Treasuries because they can diversify against the yen, which is the weakest currency in the G10, on an unhedged basis, according to Chandler.
If concerns over the Takaichi government’s stimulus efforts translate into even higher yields in Japan, that could incentivize local investors to keep more of their savings at home, but it could also mean higher yields for countries like the United States.
