Why What Happens In Japan’s Debt Market Matters To You

The Japanese yen’s turmoil threatened to hit Americans with higher prices for mortgages, investments and borrowing costs, as rising interest rates in Japan could entice investors to ditch Treasurys for Japanese bonds.

Japan held more than $1 trillion in U.S. Treasurys, making its investors a key source of financing for Washington as the national debt topped $40 trillion. If Japanese investors sell American debt to take advantage of rising returns at home, the Treasury might have to offer higher yields to attract other buyers in a bidding war, raising the government’s interest costs and potentially pushing up rates on mortgages and business loans for American consumers.

A broader retreat from U.S. assets could also put downward pressure on the dollar. A weaker dollar would make imported goods and foreign services more expensive for Americans, diminishing their purchasing power.

Japanese investors sold a net ¥3 trillion ($18.7 billion) of foreign bonds through Aug. 22, the largest year-to-date outflow since 2022, Reuters reported. Japanese government bond yields climbed to levels not seen in decades, giving the country’s investors more reason to keep their money at home.

“I know it first hand from talking to Japanese investors,” Michael Weidner, co-head of global fixed income at Lazard Asset Management, told Reuters. “They’ve underinvested in yen securities for probably 25 years. Now it’s become more attractive and they are reallocating.”

Japanese investors held approximately $1.117 trillion in U.S. Treasury securities as of June, according to Treasury Department data, down from roughly $1.225 trillion in January.

If Japanese investors sell more Treasurys, the U.S. government could have to pay higher interest rates to borrow. Treasury yields also serve as benchmarks across the American financial system, meaning higher government borrowing costs can feed into mortgage rates, corporate debt and other forms of credit.

Toshinobu Chiba, a Tokyo-based fund manager at Simplex Asset Management, told Reuters he had turned bearish on Treasurys and started buying ten-year Japanese government bonds.

“Most of the lifers have a strong incentive to buy right now,” Chiba told Reuters. “It’s a natural movement for Japanese investors to pull money out of the U.S. and back into Japan.”

Investors borrowed yen at Japan’s low interest rates, converted the money into other currencies and bought assets that offered higher returns. The trade generated profits as long as borrowing in Japan remained cheap and the yen stayed weak, but rising Japanese rates or a stronger yen could erase those gains and push investors to sell foreign assets to repay their loans.

“A stronger Japanese currency makes this strategy, known as the yen carry trade, less attractive,” Morgan Stanley wrote, warning that an unwinding could force leveraged investors to cut risk and increase volatility across stocks, bonds and currencies.

An unwinding of the carry trade could also weigh on the dollar. Investors exiting U.S. positions could sell dollar-denominated assets and use the proceeds to purchase yen to repay yen-denominated borrowing, increasing demand for the Japanese currency at the expense of the dollar.

Japan’s ten-year government bond yield rose above 3% for the first time since 1996, increasing the appeal of Japanese debt as markets expected the Bank of Japan to raise interest rates.

The United States and Japan intervened together on July 31 to buy yen after the currency fell to four-decade lows against the dollar. The rare coordinated action showed Washington’s concern that instability in Japanese currency and bond markets could spread abroad.

Washington faced growing pressure to find buyers for its debt. Federal Reserve Governor Christopher Waller said Thursday that the traditional safety premium investors once placed on Treasurys had largely disappeared and warned that the country’s roughly $40 trillion debt required structural changes.

Waller said concerns about the U.S. fiscal situation were already contributing to higher Treasury yields and argued that Washington could not simply rely on economic growth to escape its mounting debt burden.

For the United States to grow its way out of $40 trillion in debt, Waller said, structural budget deficits would have to fall from roughly 6% of GDP to near zero.

“I’ve never believed as an economist, not a policymaker, that these kind of short-run interventions do much,” Waller said of Treasury Secretary Scott Bessent’s efforts to increase buybacks of longer-dated government debt.