Investors on both sides of the Pacific are nervous, with Japan’s bond market plunging following the new prime minister’s campaign promises and U.S. markets falling under the threat of new tariffs on exports to Europe.
The turmoil in the world’s two major markets coincidentally comes as the world is awash in debt and struggling to come to terms with Donald Trump’s destructive tariff-driven trade and geopolitical strategy. The world is vulnerable to a spike in global bond yields.
In Japan, the trigger for the bond market meltdown as yields on the longest-term bonds reached record levels was Prime Minister Sanae Takaichi’s call for a snap election on Monday, which included a pledge to exclude food and beverages from Japan’s 8% consumption tax for two years at a cost of 5 trillion yen ($47 billion) a year.
For a government with a debt-to-GDP ratio of around 230 percent, the unfunded pledge was reminiscent of Britain’s Liz Truss moment. Liz Truss sparked a bond market revolt with announcements of unfunded tax cuts and spending cuts, earning her the dubious honor of being Britain’s shortest-serving prime minister in history.
In the U.S., stock markets fell more than 2% and bond yields soared following President Donald Trump’s threat to impose new 10% tariffs on eight European and Scandinavian countries, raising tax rates to 25% in June if Greenland is not handed over to the United States. He also threatened to impose a 200 percent tariff on French champagne if France did not join his “peace committee.”
Unsurprisingly, gold prices, which have been on a record decline since Trump returned to office and launched trade wars with countries around the world, hit a new record on Tuesday.
The spike in global bond yields (Australian bond yields also rose across the board on Tuesday) comes amid a sea of global debt, with the global debt-to-GDP ratio now exceeding 235 percent. In the United States, this ratio is about 125 percent, and in Japan, the world’s most indebted developed country, it is about 240 percent.
Although not alone, the world’s major economies, the United States and Japan, home to two of the world’s most important financial centres, are particularly vulnerable to sharp increases in government borrowing costs.
President Trump has shown he is sensitive to developments in the U.S. bond market, rescinding his announcement to impose tariffs on April 2, Emancipation Day, after the U.S. bond market plunged and yields soared.
Mr. Takaichi is riding a wave of popularity with policies that appear to be aimed at growing Japan out of a potential debt trap and causing inflation, but he doesn’t seem to be too afraid of the market’s bond vigilantes.
The cross-currents caused by changes in U.S. and Japanese bond yields are complex but potentially significant.
On Tuesday, Japan’s 10-year bond yield rose 10 basis points to 2.34%. At the beginning of the year, it was 2.06%. The changes in long-term bond yields were even more pronounced, with the 30-year yield rising 27 basis points to 3.4% and the 40-year yield exceeding 4% for the first time.
In the United States, the 10-year Treasury yield rose 15 basis points to 4.29%, and the 30-year Treasury yield rose 9 basis points to 4.92%. (There is an inverse relationship between bond prices and yields; as prices fall, yields rise).
Japan’s bond market is dominated by domestic investors, who hold about 90% of bonds, and after more than a decade of quantitative easing, the central bank, the Bank of Japan, owns more than half of all bonds.
Therefore, the apparent “Sell America” movement since Trump returned to office is thought to be less susceptible to capital flight than the U.S. market.
It also raises the possibility that Japan’s domestic investors, who have been exporting capital since the real estate bubble burst in the early 1990s and the economy entered a prolonged deflationary winter, may begin to repatriate their funds, citing higher yields and favorable currency hedging costs, as hedge funds unwind trades once the dust settles and losses on existing trades are absorbed, leaving long-term investors already in the red.
This will have major implications for other markets, particularly the United States, where Japanese companies hold about $1.2 trillion ($1.8 trillion) in U.S. Treasuries.
The cost of President Trump’s One Big Beautiful Bill tax cuts is expected to hit and the U.S. deficit and debt are set to rise, and a significant loss of support for U.S. Treasuries would have a negative impact on bond prices and yields.
America’s credibility is declining, and confidence in the stability of the government and the American judicial system is eroding.
President Trump has shown how sensitive he is to U.S. interest rate developments through his fierce criticism of the Federal Reserve and his continued attempts to gain influence and control over interest rate-setting decisions. He wants to lower interest rates to address America’s affordability crisis and lower the cost of servicing rising debt levels.
Although there has been a “Sell America” moment in response to President Trump’s erratic and aggressive policy decisions, it has not resulted in a large-scale exodus where the United States is vulnerable due to its debt and current account deficit.
The United States needs to borrow money from the rest of the world to maintain its growth and standard of living, and it is able to do so because of its market and economic advantages, its trust in its courts and other institutions, and the important role and power of the U.S. dollar in global economic and financial activities.
The dollar weakened against a basket of currencies from major trading partners, losing 0.8 percentage points on Tuesday. It has fallen 9.8% versus the basket since President Trump took office, reflecting some capital flight.
This could become even more threatening if European institutions and governments, which hold more than $12 trillion in U.S. assets, the largest source of foreign investment in the U.S., start selling off some of those assets, as some in Europe have suggested.
It is unlikely that it would occur on a large scale, but most of it was owned by private companies and could not direct their actions. But even a relatively small sale could have an impact, especially if it coincides with the withdrawal of Japanese investors from the U.S. market.
In any case, it may be happening at a modest level. America’s credibility is declining, and confidence in the stability of the government and the American judicial system is eroding. The decline in the US dollar reflects the deterioration in the perception that the US is a good and safe investment destination.
Some funds have reduced their exposure to the U.S., citing the instability of the U.S. political and economic environment and the stock market’s concentration in a small number of artificial intelligence stocks. Akademi Carpension, a Danish fund manager with about $25 billion under management, said it would sell about $100 million in U.S. bonds this month.
Norway (which President Trump appears to have confused with Denmark when asking the US for permission to buy Greenland) has a $2.1 trillion sovereign wealth fund with more than half of its assets in the US, including about $184 billion in US debt. In the current situation, you may decide that it is better to reduce your exposure.
China, once the largest foreign investor in U.S. Treasuries, has been steadily shedding its holdings, which have fallen by 10% over the past year to about $680 billion. Just over a decade ago, the company held about $1.2 trillion in these securities.
It won’t take long to prompt a broader sell-off of U.S. debt that would force the Trump administration to rethink its strategy of relying on the countries it targets by simply doing what it’s told to do under the threat of tariffs.
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Stephen Bartolomeusch is one of Australia’s most respected business journalists. He was most recently co-founder and deputy editor of the Business Spectator website and deputy editor and senior columnist for The Australian.connect via email.