Japan’s Bond Meltdown Is A Warning To Trump World

Shorting the Japanese government bond market has long been a “widowmaker” trade. Many people have tried over the past 15 years; few, if any, have been truly successful.

Last week may have been the moment Japan’s debt-bearers have been waiting for years. Since Monday, yields on many Japanese government bonds have surged to their highest levels since 1999. The interest rate on Tokyo’s 40-year bonds reached 4%, a 31-year high.

The reason: Prime Minister Takaichi Sanae plans to open the fiscal floodgates and support the continued depreciation of the yen. The market was further spooked by the high market’s announcement of a snap election on February 8. Traders know she is seeking a public mandate to increase public debt, which already stands at 260% of gross domestic product (GDP), which is unsustainable.

It’s a painfully familiar action. Since the mid-1990s, one government after another has wantonly increased Tokyo’s debt burden. Leader after leader has urged the Bank of Japan to cut interest rates. In 1999, Japan became the first G7 country to lower its benchmark to zero. Two years later, the Bank of Japan took the lead in launching quantitative easing policy.

The interest rate is still only 0.75%. The Bank of Japan is even less likely to raise interest rates on Friday.

The bond drama in Tokyo this week has investors worried that Asia’s second-largest economy is losing control of its finances. Yet it is also telling that Japan’s turmoil spread so quickly to U.S. Treasuries. The question is, how concerning should this dynamic be for President Donald Trump’s Treasury Department?

Citadel CEO Ken Griffin also worries the problem is bigger than the White House realizes, calling it a “clear warning.” As Griffin told Bloomberg: “Bond vigilantes can come out and extract their prices. What’s happening in Japan sends a very important message to the House and Senate: You need to get our fiscal house in order.”

Of course, with the national debt soaring to $39 trillion, Washington is racing in the other direction. This debt burden is 9.7 times Japan’s annual GDP of US$4 trillion. Trump has been outspoken in saying he wants the Fed to follow the Bank of Japan’s lead and cut U.S. interest rates to 1% or lower. He is following Federal Reserve Chairman Jerome Powell in an unprecedented move in trying to engineer Japan-level interest rates.

At the same time, the U.S. debt burden is becoming increasingly problematic. Full-year net interest expense on debt reached $514 billion, exceeding defense ($498 billion) and Medicare ($465 billion). Such a turning point makes it difficult to dispute Moody’s Investors Service’s decision last year to withdraw Washington’s last AAA credit rating.

Trump’s tariffs and chaotic foreign policy are causing top U.S. government bankers to worry about the direction of Treasury yields. The governments of Japan and China collectively own $1.8 trillion of U.S. public debt. Asian governments have long been the biggest reason why Washington cannot make ends meet due to their large holdings of U.S. dollars.

It’s hard to imagine these countries thinking now is the time to continue increasing their engagement with Washington.

As Griffin told Bloomberg, “The United States has so much wealth that we can sustain this level of deficit spending for a while. But the longer we wait to change course, the more severe the consequences of that change will be.”

Meanwhile, billionaire investor Ray Dalio worries that Trump’s aggressive presence on the world stage could make investors around the world reconsider the safety and appeal of dollar assets.

“The other side of trade deficits and trade wars is capital and capital wars,” Bridgewater Associates founder Dalio told CNBC. “If you think about conflict, you can’t ignore the possibility of capital wars. In other words, maybe people don’t have the same inclination to buy U.S. debt and so on.”

Dalio added, “We know that holders of dollars are denominated…and those countries that need dollars, which is the United States, worry about each other. Right? So if other countries hold dollars and they worry about each other and we’re producing a lot of dollars, that’s a big problem.”

The bottom line, Dalio noted, is that “when there’s a conflict, an international geopolitical conflict, even allies don’t want to hold each other’s debt. They prefer to use hard currency. That’s logical, it’s true, and it’s repeated throughout world history.”

Not surprisingly, with the Japanese bond market turbulent and U.S. debt volatile, gold prices surged to new all-time highs. If Trump and Treasury Secretary Scott Bessent aren’t careful, short sellers from Tokyo to Washington could finally have their moment.