Quick Bites | Bond Vigilantes Come for Tokyo

As F Scott Fitzgerald famously said about bankruptcy, “How did you go bankrupt? Two ways. Gradually, then suddenly.” Japanese bonds are making global headlines in the past week for all the wrong reasons. They are spiking higher as concerns mounts over profligate fiscal loosening amidst the election campaign set for early February.

The yield on Japan’s 40-year government bond on Tuesday rose above 4% for the first time since Tokyo started issuing that maturity in 2007. Yields across the curve surged; the 10-year briefly touched 2.33%, its highest since 1999.

Source: Financial Times

Some of this reflects global market unease about the rift between President Trump and Europe over Greenland. But investors in Japan appear more worried about the snap election Prime Minister Sanae Takaichi has called for next month.

The Catalyst

Fiscal expansion (lower taxes) is a central element of Takaichi’s economic plan. The election campaign will focus on her pledge to reduce the consumption tax for select purchases for 2 years, with a revenue loss of about $30 billion a year.

This includes Ms. Takaichi’s ¥18.3 trillion ($116 billion) “stimulus” package, approved in November. That plan offered energy subsidies, cash handouts to households to counter inflation, and industrial-policy subsidies in areas such as semiconductors and artificial intelligence.

The problem – and the real reason for the bond vigilantes to ride into town – is that none of this does anything to boost economic growth. Japan has developed a habit of throwing cash around to no advantageous effect other than to accumulate debt.

General elections are scheduled to be held on 8 February 2026 to elect all 465 seats of the House of Representatives, the lower house of the National Diet. The election will be held 4 months into Takaichi’s tenure as Prime Minister, which began on 21 October after she won the 2025 Liberal Democratic Party presidential election and formed the Liberal Democratic Party–Japan Innovation Party coalition.

Economic Background

Japanese economic and financial problems have been decades in the making. The more immediate problem is that the Bank of Japan has been trying to normalize monetary policy by raising its main policy rate since early 2024. However, inflation remains stuck around 3.0%, well above the BoJ’s 2.0% inflation target and the current policy rate of 0.75%. The BoJ is tightening too little, too late, because the economy is weak, prompting the new government to push for fiscal stimulus. That will widen Japan’s government deficit, adding to the already record high public debt. The Bond Vigilantes are protesting by driving bond yields higher.

None of this profligate government spending has created much economic growth. Instead, it has amassed debt equal to 250% of GDP, up from about 63% in 1990. That statistic is telling: if all the earlier stimulus efforts had spurred economic activity, GDP growth would have outpaced the accumulation of debt. It hasn’t.

Instead, debt service consumes 25% of the government budget ($178 billion) in fiscal 2025 for interest and redemptions combined. Defense spending is 7.5% of the budget, less than the interest on the debt. Investors are right to wonder how these numbers can add up in the future, especially as the Bank of Japan raises its policy interest rate to suppress persistent inflation.

While Japan’s government debt crisis is pushing bond yields higher, we don’t expect that it will cause a global financial crisis. Nevertheless, Japan’s Bond Vigilantes are sending a clear message to governments worldwide about the need for fiscal discipline.

Source: Yardeni Research While the Japanese surge in bond yields has yet to torch other bond markets, the pressures are building.

Source: TopDown Charts

What are the new pressures that Japan is facing?

The surge in bond yields is not just about BoJ policy. More than that, it reflects a fundamental “breakout” in Japan. They are in the early process of shaking off the stagnation and deflation of previous decades, and are now seeing a major upturn in nominal growth. This has meant excellent returns for Japanese equities (the Nikkei 225 is up 33% year on year), but also means a reality of a new normal higher-for-longer dynamic playing out in the Japanese government bond market.

This has the potential to ripple into global markets due to the traditional importance and influence of Japan in carry trades. The potential is there for spillover into higher global yields (including the US and Australia), different forex market behaviour than the past (higher Yen, lower USD), and possible repatriation flows from carry-trade unwinds if domestic yields get attractive enough.

In other words, we need to adjust how we look at Japan as it meets these new structural challenges.

Source: TopDown Charts

Tokyo’s gradual monetary normalization and its dire fiscal situation rank among the more serious threats to global financial stability at present. Japan is an extreme case of a high-debt-low-growth policy model that infects other Western economies. How Tokyo does or doesn’t fix this will serve as a lesson, or a warning, to all of us.