The Land of the Rising Sun is not generally of much interest to global investors — until something goes really wrong, when it does. Japan’s $7.8 trillion government bond market is suddenly causing major financial shocks around the world.
A few days ago, Japanese government bonds (JGBs) were the usual haven of calm with ultra-low yields, sluggish liquidity flows and trading volume when most of the investment universe’s rulers are out of options. However, a disastrous bond auction on May 20 quickly thrust Japanese debt into the center of the global economic conversation. And for that, investors have Donald Trump and his tariffs to thank.
Japan’s debt market has begun to wobble, just like the US.
The world’s No. 1 and No. 3 economies are currently fending off the “bond avengers” at a time when the euro’s share of foreign exchange reserves is just 20%, suggesting that global safe havens are increasingly hard to find.
Investors can’t seem to decide which major economy is riskier.
- The US and all that Trump is about?
- Japan and the baggage of a lost decade of anaemic growth and its current inflation woes?
- Or China, with its rising deflation and persistent property crisis?
Perceptions of all three economies tend to shift constantly.
Japan, one of the world’s most indebted developed economies, also became a kind of savior for its own bond market and the global debt market this week. But the trend is that investors have focused on the fiscal imbalances of developed economies and do not seem to want to “feed” leveraged money to the “twin” government deficits.
Long-Term Yields
When Reuters reported on Tuesday, May 27, 2025, that Japan’s Ministry of Finance (MOF) might reduce issuance of ultra-long-term debt, bond markets from Japan and South Korea to Britain and the United States reacted positively to the news, pushing prices higher and yields lower.
This stopped a week-long sell-off in bonds triggered by investors demanding higher yields as they braced for higher inflation and government spending triggered by US President Donald Trump’s trade and tax policies.
Yields on 40-year Japanese government bonds (JGBs) had hit a record high of 3.675% last week and were down 40 basis points from that level.
Yields on 30-year U.S. Treasuries have fallen below a key 5% rate, helping the yield curve become less steep. Japan’s proposal has stabilized the debt of all advanced economies.
As deficits widen, this will be a test for other countries of whether greater flexibility in how to schedule issuance is an attractive option.
Supply and demand mismatch
Japan will be a test for the world on how best governments handle the mismatch between supply and demand in the government debt market.
As of Wednesday (28/5), after the auction of 40-year JGBs, investors have not been convinced by the idea. Demand at the auction was at its lowest point since July. A week ago, investors had resoundingly abstained from the auction of 20-year bonds, which was Japan’s worst auction result since 2012.
For now, we have less turbulent markets and some time to catch our breath, but, in the big picture, these are just aspirins.
All of this is intended to help the market function in the short term, but it does little to alleviate concerns in the medium and long term, because the underlying causes of these concerns have not disappeared and are not helped by increased funding from short-term financial instruments.
Portfolios will need to be rebalanced to reduce exposure to long-term bonds and diversify into markets with healthier fiscal conditions or more attractive yields, such as Germany, Poland and Romania.
Dancing with the Sharks in the Debt Market
Japan is not alone. The U.S. Treasury plans to issue $514 billion in new debt in the second quarter and $554 billion in the third quarter to finance a $2 trillion deficit, with $9.2 trillion in debt maturing this year, much of it short-term. Refinancing at higher yields has pushed annual interest costs to $952 billion, outpacing defense spending and crowding out other fiscal priorities.
In Europe, France’s political crisis, marked by intense political wrangling over its budget, has pushed the spread of its 10-year bond against German bonds to a 2012 high of 108 basis points. The prospect of Germany easing its debt brake could boost borrowing, with €450 billion in eurozone debt to be issued in the first quarter of 2025 alone.
Investors everywhere echo this sentiment, expressing concern about governments’ ability to manage deficits without destabilizing markets.
Britain’s debt management agency said there would be a “significant shift” away from long-term debt in the next financial year in response to rising borrowing costs and weaker investor demand. Britain plans to issue 299 billion pounds ($402.6 billion) in government bonds this year — the second-highest amount on record — and its bonds have come under pressure from concerns about high debt levels and bond issuance.
Japan’s situation is more complicated than elsewhere, with its debt 2.5 times the size of the economy and its central bank having scaled back bond purchases. The fact that governments are reshaping their debt and capital-raising plans shows they are listening to markets, rather than letting central banks manage yields through monetary tools.
The U.S. Treasury has been gradually reducing the maturity of its debt for years by issuing more short-term bonds as long-term bonds mature, increasing overall debt.
The Fiscal Gap with Tax Cuts
If Trump’s “big, beautiful tax bill” passes in the coming days, it is estimated to add about $3.8 trillion to the federal government’s $36.2 trillion debt over the next decade.
When Moody’s Investors Service downgraded the U.S. rating this month, it predicted that the U.S. public debt, now about 100% of gross domestic product, would rise to 134% over the next decade.
The Treasury Department is finding that the market has no appetite for anything at the long end of the curve unless interest rates are above 5%, Trust Economics reports. This will force them back to the short-term end of the curve in terms of new issuance.
Germany is the only G7 economy with a debt-to-GDP ratio below 100%, but investors have also sold off its bonds in recent months on expectations of more supply after the unexpected creation of a 500 billion euro ($565 billion) infrastructure fund.
The market is sending a signal that concerns about fiscal and debt sustainability are growing. Market participants want to see policymakers use a multi-pronged approach to address deficits and reduce the associated risk of debt issuance.
The “bond market vigilantes” for the US
It is only a matter of time before there is a crack in the bond market, as the US government and the Federal Reserve have “massively overdone” fiscal spending and quantitative easing.
US Treasury bonds are on track for their first monthly loss this year as President Donald Trump’s abrupt policy changes shake investor confidence. Concerns about the budget deficit increased in May due to a tax cut bill being pushed through Congress.
Concern about the “bond market vigilantes”
The so-called “bond market vigilantes” are back. Fixing the US banks’ supplementary leverage ratio and other “deeply flawed” regulations that, if fixed, would allow banks to more actively intervene in the market.
The reality can no longer be glossed over as the de facto cost of borrowing for governments is rising – for now, for long maturities.
