Flipping the Yen

Is Japan now finally allowing the bond market to blow out instead of the Yen?

I have long been writing about the economic singularity that is Japan. In fact, just last week I published a mini documentary on a trip I did to Japan to visit with Weston Nakamura (of across the spread fame), another substack writer and macro analyst.

A longer documentary is coming shortly.

Japan has for decades been the land of economic contradictions. Yield Curve Control and massive QE, but no inflation. Excessive fiscal stimulus, but no GDP growth. Low rates, but no depreciation of the currency.

All of this was enacted in the wake of the popping of the largest asset bubble the country had ever seen. In many ways, the Bank of Japan itself was responsible for igniting the bubble as laid out in Princes of the Yen.

They lowered interest rates to 2.5% and increased usage of the window guidance program in order to stimulate massive amounts of credit creation, which juiced land and stock prices.

As the bubble had popped, and as the BOJ tried more and more desperate measures in order to escape the slow rolling deflation that had begun to affect the markets and broader economy, many people had assumed that everything would go awry very quickly.

Instead, what happened was three decades of no growth, but no inflation. A sort of zombification of the entire system set in. With rates at zero, companies could refinance even extremely high debt loads with ease.

For a long time this worked. Because of the demographic collapse that Japan was experiencing along with the cultural proclivity towards saving; highly stimulative programs like yield curve control and even the Three Arrows fiscal program proved ineffective at sparking inflation.

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Now, again, back to the article!

Even the infamous JPYUSD currency pair stayed range-bound below ¥110 to the dollar.

All of this changed in 2022. In March, the Fed began its fastest rate-hiking cycle ever, while Japan was still pinned below zero. With no major pivot to the monetary policy in decades, and with borrowing being essentially free, a massive carry trade opened up on the Yen.

I started warning in 2022 and into 2023 that this would cause the yen to depreciate rapidly and force the Bank of Japan or the Ministry of Finance to take emergency actions. This thesis proved to be correct.

The Yen blew out from 113 in February to 148 by October, a devaluation of almost 30%. And right in line with the rate hikes done by the Fed.

In late September, the Bank of Japan began to do currency market interventions, something it had not done since 1998. It blew through ¥2.4 trillion in order to stabilize the rate.

It followed up with more interventions in October. These tremors were bigger, with a massive ¥6.35 trillion being needed to bring the rate down this time. In total, interventions for these two months totaled around $62B USD. At that rate, Japan had about 30 months of ammo left in the stockpile to hammer the rate with. (This large stockpile of USD is thanks to their large trade surplus with the US- think Toyota and Honda).

By December, the situation was getting dire and not wanting to blow any more precious US dollar liquidity on the currency market, the BOJ decided to start lifting the bands on yield curve control. It moved the upper band to 0.5%, above the zero bound for the first time since YCC was implemented in 2016. This immediately caused a shock to the market and even a margin call by the Japan Securities Clearing Corporation.

Japan was being faced with a choice: save either the currency or the bond market. So far, it had been successful in sitting one ass on two horses, doing monetary easing on one hand (printing yen) and doing massive currency market interventions (burning dollars) on the other.

(This is commonly known in macro, so much so that it has become a common refrain. Save the currency or save the bonds is a meme that even Lyn Alden and Luke Gromen have repeated).

The move bought some time.

In 2023 and 2024 the trend continued unfortunately. Despite the BoJ hiking out of the negative bound in March 2024 and signaling that QE would be reduced going forward, the Yen kept retesting the 150 mark, which was a redline for Japanese officials.

The BoJ intervened in April 2024, right after their policy meeting, and again in early May, after the FOMC meeting. All of these actions were signs that they were panicking- and for good measure.

Unlike the United States or China, Japan imports the vast majority of its food and energy. Nearly all of its oil, natural gas, and coal must be bought from abroad, priced overwhelmingly in U.S. dollars. The same goes for key agricultural commodities, like wheat and soybeans, as well as processed food inputs and animal feed. So when the yen falls, from 110 to 150 per dollar, the cost of those imports skyrockets in yen terms.

That’s why recently Japan saw its trade balance flip deeply negative, with energy imports leading the deficit. Households faced rising electricity bills, higher gasoline prices, and a spike in grocery costs even as domestic wages remained largely stagnant. But the worst part of all this is that the inflation comes from currency depreciation, meaning Japan experiences the pain of rising prices without the growth or fiscal stimulus that typically justifies it.

This is why the BoJ was forced to change course. But at the time, in pieces like Tokyo Drifting into a Currency Crisis, I assumed that the BoJ might allow some minor tweaks to rate policy in order to catch Yen shorts off guard (allowing the borrow leg of the carry trade to go up will result in losses), but that they would never allow anything close to policy rate normalization to occur.

The cost to the government in the long run would be too much. They wouldn’t even dare step in that direction.

I was wrong.

From June 2023 to now, the ultra long end (Japanese 30 and 40 yr bonds) have blown out from 1.17% and 1.36% to 3.03% and 3.34% respectively, a doubling of the yield in just two years. Similar increases are seen for the 20yr and even the mighty 10yr bond, which was once the target of yield curve control.

This is where the contradiction at the heart of Japan’s policy becomes visible. Japan has the highest government debt-to-GDP ratio in the developed world, at over 260%, and its fiscal position depends on ultra-low borrowing costs. Even small increases in yields begin to stress the system. Pension funds, banks, and insurance companies, many of which are stuffed with JGBs, face mark-to-market losses and duration mismatches. In the past, the BOJ would step in to contain that damage.

At that high of a debt level, each 1% increase in bond yields (which eventually roll into average debt interest rate) means an increase in interest expense equal to 2.6% of GDP. If they normalized rates with the Fed, and the entirety of Japanese debt was refinanced there, they’d be paying 11.2% or so of GDP each year in INTEREST EXPENSE ALONE.

The reason why they’re going ahead with this now is because of something I hadn’t considered. First, it takes time to refinance the bond profile, and this won’t happen overnight, given that Japan did issue a lot of long term debt to take advantage of low interest rates. But, a blowout in interest expense is the long term scenario that policymakers would face.

In fact, take a look at this chart I made on Japanese debt maturity- about 80% is 10 years or more, which makes sense given the decade or so of yield curve control that targeted that maturity.

If we dive into their maturity profile, we can see that although the majority of bonds are on the long end, a lot of the bonds were issued in 2016 due to the advent of YCC. This means they have a maturity wall to face in 2026.

I downloaded data from the Ministry of Finance and wrote a python script to express the data in a bar chart. The severity of the 2026 refinancing is quite apparent here, and up until 2035 they are refinancing around ¥50T mark every single year.

This means that if the Japanese allow rates to stay elevated, they will start facing the same interest rate expense doom spiral that the US is currently ensnared in. Now they do not have to issue 10 year JGBs or 30 year JGBs when they refinance the expiring bonds, but they do have to roll over the debt in some way.

They could try the american strategy of pushing issuance to shorter and shorter durations, which would inevitably create more inflation as bills are more stimulative than bonds.

Either way, conditions are changing.

The yen is no longer being left to float freely in times of stress. Instead, when speculative pressure builds, Tokyo is willing to sell reserves, issue verbal warnings, and let yields rise. The market is learning that the new regime is one in which the pain will not be shouldered by the currency alone.

And while that does relieve pressure on the currency, it severely limits the ability of the government to engage in deficit spending without causing a debt crisis or inflation crisis.

There’s truly no way out. You can’t avoid financial gravity forever.

The global implications of this shift are massive. Japanese investors are among the largest holders of foreign debt, especially U.S. Treasuries and European sovereigns.

If domestic yields rise, the incentive to recycle capital abroad diminishes. That would put upward pressure on global interest rates just as Western economies begin cutting. At the same time, a more volatile JGB market could spill over into broader risk sentiment, triggering liquidity strains in Asia and beyond. Japan’s long-standing role as the global funder of sovereign debt may finally come to an end.

As this continues, we’d see more and more upward pressure on global bonds, especially long bonds- which is exactly what is happening to the U.S. 20Y and 30Y tenors. It’s not surprising.

The Japanese have a record $7.2 trillion USD worth of savings, around 54% of household assets, in cash. They have four times the savings rate of the next highest G7 country. They are essentially a cash cow.

With bond yields rising, this means that any investors parked there will begin facing losses. As inflation rises, the savers will start moving capital into safer assets. The likely beneficiaries, as laid out in that aforementioned documentary, are US equities, gold, and bitcoin.

The liquidity wave will begin to shift. And like last time, the Japanese Godzilla will move markets.

In the end, this monetary madness reflects a broader truth: no country can suppress all market signals forever. Something has to give. For years, Japan let the yen absorb the pressure. Now, as inflation returns and credibility becomes scarcer, the bond market is being asked to carry the burden.

The era of sacrificing the yen may be temporarily over, but what replaces it might prove even worse.