‘Liz Truss-lite’: Is Japan in the midst of a sovereign debt crisis?
Japan’s long-dated bonds suffered their worst sell-off this century on Tuesday. Ali Lyon asks whether the rout could spark a full-blown debt crisis?
For decades, the world’s fixed income investors have been sucked in – and spat out – by an alluring trade on Japan’s government bonds.
Secure in their belief that the securities’ unfathomable, quantitative-easing-fuelled heights were unsustainable, gaijin fund managers would bet on Japanese borrowing costs correcting to a more conventional rate. And sure as night follows day, those investors got burned.
The turn of events became so predictable, that the trade was given an alarming sobriquet: ‘the widow-maker’. Last year, though, with a Japanese economy showing signs of life after a half-century of stagnation, more cocksure asset managers made serious returns, as bond yields climbed to their highest level in more than 25 years. The widow-maker forged rainmakers.
On Tuesday, 2025’s reversal of a decades-long trend evolved into a full-blown bond meltdown. The price of its bonds, which move inversely to yields, plummeted in one of the most sudden sell-offs of government debt this century.
The interest rate on the country’s longer-dated IOUs climbed some 25 basis points – or quarter of a per cent – in a single session. And the yield on its 40-year coupon, the longest term security issued by Japan’s finance ministry, rose above four per cent for the first time since they were introduced in 2007.
Japanese bonds in ‘very serious trouble’
“Japan is in very serious trouble,” wrote Robin Brooks, a senior fellow at the Brookings Institution, in a note on Tuesday. “The kind of jumps in long-term yields we’ve seen there are highly unusual.”
The culprit – in most people’s eyes – is Japan’s uncompromising new Prime Minister, Sanae Takaichi. Crowned by her colleagues as the country’s first female leader in October, the staunch conservative promised to juice the economy with a rapid loosening of fiscal policy aimed at ameliorating the sharper ends of a cost-of-living crisis. Initially, the slim majority she inherited frustrated those efforts. Last week, she called a snap election in search of a mandate for her agenda from the electorate.
Since then, Takaichi – whose political idol is Margaret Thatcher – has promised to cut levies on food for up to two years. But with no indication of how her government plans to fund the move, investors have taken fright.
“This move can only be described as a total rout that illustrates a complete loss of confidence in JGBs [Japanese government bonds],” said Derek Halpenny, head of research at the international arm of Japanese bank MUFG.
Absent the tax rises or spending cuts to plug the hole, he continued, fixed income traders understandably fear they will be the people Takaichi turns to pick up the slack.
While the promise of a single unfunded tax rise would raise concern among investors in most developed economies, it would be unlikely to wreak the havoc that has played out in Tokyo this week.
But Japan is not an ordinary economy. Ever since the country’s economic foundations were shaken by the bursting of a historic asset bubble in 1991, its central bank and politicians have pulled every lever available to them to spark economic growth. Gargantuan levels of government borrowing – funded by equally mind-boggling central bank bond purchases – were the main means, carrying its debt to GDP ratio to the wrong side of 200 per cent.
The UK has a debt ratio is roughly half that, while Germany’s sits pretty at around 60 per cent.
Truss 2.0: Will rout spark a debt crisis?
Takaichi may like to compare herself to the Iron Lady, but after this week, comparisons have been made to another female British prime minister, one who oversaw her own debt crisis.
“Japan appears to have had a Liz Truss-lite moment,” Ken Griffin, the chief executive of Citatel Securities told a World Economic Form event, referring to the short-lived PM’s fateful mini-Budget that unleashed chaos on the UK’s bond market.
“This was one of the biggest moves in yields this century,” he said, adding: “Bond vigilantes are back.”
According to Helen Thomas, the founder of Blonde Money, the worry now should be whether fear bleeds into bond markets closer to home, endangering a quiet rally in the UK’s bonds that has seen government borrowing costs fall to their lowest since 2024.
“The risks now are of contagion,” she told City PM. “Japanese institutions such as as Sumitomo Mitsui have announced plans to double their JGB portfolio in the wake of more attractive domestic yields.”
In other words, with Japanese bonds now offering investors higher yields, the demand for equally high-yielding UK bonds, known as gilts, may dry up, renewing concerns over the UK’s fiscal imprudence that have plagued successive governments ever since the mini-Budget.
Where does this end? For Brooks, the Bank of Japan will “no doubt” step in as a buyer of last resort for the nation’s long-dated bonds, helping bring down the country’s borrowing costs and preventing a full-blown debt crisis. But doing so would involve printing more money, which will further way on a yen that is already at multi-year lows.
Then there’s the United States, whose gaping budget deficit stands at north of six per cent. If investors suddenly take a disliking to that, the effects, in Griffin’s eyes, would be “far more devastating”.
For now, the ructions appear restricted to Japan. And the widow-maker trade is on.