TOKYO \u2014 Bond traders seem to be sending a message to the Bank of Japan and the Ministry of Finance that the late 1990s are back.<\/p>\n
Yet far from partying like it\u2019s 1999, the rise in 20-year yields back to levels from that year suggests trouble ahead for Asia\u2019s second-biggest economy \u2014 and perhaps global markets<\/a>.<\/p>\n It was 26 years ago when the BOJ cut rates to zero, the first major monetary authority to do so. This week, the 20-year Japanese government bond (JGB) rate rose to 2.655%, the highest level since 1999. It sparked a level of volatility Tokyo markets haven\u2019t seen in years.<\/p>\n Since 1999, a succession of BOJ leaders<\/a> have been trying to get short-term rates closer to 1% than 0%. To no avail. Today\u2019s BOJ Governor Kazuo Ueda has gotten no further away from zero than 2003-2008 Governor Toshihiko\u00a0Fukui.<\/p>\n Between 2006 and 2008,\u00a0the Fukui BOJ board managed to scrap quantitative easing, a policy dating back to 2001. Fukui pushed benchmark rates to 0.5%, the same level as today. Then came the 2008 \u201cLehman Shock,\u201d and with it a return to QE and zero rates.<\/p>\n In 2013, the BOJ went ever further than that. Under the leadership of then-Governor Haruhiko Kuroda, the BOJ hoarded JGBs and stocks as never before. By 2018, the BOJ\u2019s balance sheet topped the size<\/a> of Japan\u2019s $4.2 trillion economy, a first for a Group of Seven member<\/a>. The BOJ\u2019s yield-curve control policy effectively pushed rates into negative territory.<\/p>\n Enter Ueda, who took the helm in April 2023 determined to normalize Japan\u2019s rate environment. Then came US tariffs. The trade war has the Ueda BOJ halting its rate hike cycle.<\/p>\n With Japan seen growing all of 0.7% this fiscal year and tariff-related storm clouds gathering, the BOJ is essentially stuck at 0.5% until it knows where US President Donald Trump plans to take his trade war in the months ahead. It\u2019s not clear even Trump knows, as China, the real target of tariffs, is slow-walking trade deal negotiations.<\/p>\n If Chinese leader Xi Jinping opts against the splashy \u201cgrand bargain\u201d deal of Trump\u2019s dreams, the US leader might lash out everywhere in anger. Officials in Tokyo worry Trump might then impose a universal tariff<\/a> stacked on top of the 15% rate Japan negotiated.<\/p>\n In the interim, China concerns abound, keeping the Tokyo policymakers stuck in economic limbo. Mainland growth appears to be slowing across the board. If the BOJ continues tightening as China slows, might it just hasten Japan\u2019s slide into recession?<\/p>\n Some economists think the BOJ will continue tightening. \u201cWith the economy holding up well and tariff-related uncertainties abating, the [BOJ] should feel comfortable with resuming policy normalization before long,\u201d said Abhijit Surya, economist at Capital Economics.<\/p>\n Yet as economist Annabel Fiddes at S&P Global Market Intelligence pointed out, soft domestic demand and a darkening external scene are complicating Japan\u2019s year. A \u201crecovery in manufacturing output may be hard to sustain unless we see an improvement in sales in the near-term,\u201d Fiddes said.<\/p>\n The plot thickens when you consider why JGB yields<\/a> are returning to 1999 levels: worries that Tokyo is about to open the fiscal floodgates to juice the economy.<\/p>\n Japan has by far the worst debt burden among developed nations. By some measures, it\u2019s 260% of gross domestic product. That might seem less troubling if Japan\u2019s population weren\u2019t shrinking and aging at a rate that worries demographers as much as holders of 20-, 30- and 40-year JGBs.<\/p>\n An added complication: how dismally the ruling Liberal Democratic Party performed in July elections. Odds are good that embattled Prime Minister Shigeru Ishiba<\/a> will green-light increased public spending, a step that might irk credit rating companies.<\/p>\n \u201cLooking ahead, with concerns about fiscal expansion remaining strong, the ultra-long-term zone as a whole is likely to face upward pressure,\u201d wrote analysts at Mizuho Securities.<\/p>\n In July, net foreign purchases of JGBs maturing after 2045 fell to just $3.3 billion. That was just a third of the level<\/a> of purchases in June, a sign Japanese debt may be losing its safe-haven bid.<\/p>\n On August 19, the MOF attracted only tepid demand for a sale of 20-year sovereign bonds. It\u2019s become something of a pattern. Weak auctions in June and July spooked investors, too.<\/p>\n As Tokyo has difficulty selling JGBs, the yen could be vulnerable. A sudden yen plunge could have two immediate implications.\u00a0<\/p>\n One is the so-called \u201cyen-carry trade\u201d blowing up. Japanese rates at zero since 1999 turned Japan into the globe\u2019s top creditor nation. For decades, investment funds\u00a0borrowed cheaply<\/a>\u00a0in yen to bet on higher-yielding assets around the globe. <\/p>\n As such, sudden yen moves slam markets virtually everywhere. It became one of the globe\u2019s most crowded trades, one uniquely prone to correction. Arif Husain, head of fixed income at T. Rowe Price, calls the yen-carry trade the \u201cSan Andreas fault of finance.\u201d<\/p>\n Another: a weaker yen would surely provoke the ire of the Trump White House. The slightest suggestion Tokyo is manipulating exchange rates could have Trump threatening to increase the 15% tariff rate. Since the specifics of the US-Japan tariff arrangement aren\u2019t written down on paper, Trump could always renege.<\/p>\n Tokyo worries a sliding yen would have Trump gunning for Ishiba. This could include Trump\u2019s Treasury Department slapping the dreaded \u201ccurrency manipulator\u201d label on Tokyo.<\/p>\n This has Japanese officials anxious to manage the\u00a0currency \u2014 and to keep the yen off the radar screen. The BOJ and Finance Minister Katsunobu Kato have so far managed to limit the yen\u2019s downside.<\/p>\n Suspicions are rife that Trump is pressuring Treasury Secretary Bessent \u2014 a hedge fund veteran who presumably knows better than \u2014 to weaken the dollar<\/a>. This goal is partly why Trump is prodding the Fed to slash borrowing costs.<\/p>\n Trump has threatened to fire Fed Chair Jerome Powell. He\u2019s calling on Fed Governor Lisa Cook<\/a> to resign and has his Justice Department investigating her. As Trump damages trust in the Fed\u2019s independence one social media post at a time, the dollar\u2019s troubles are mounting in real time.<\/p>\n Asia worries Trump will force Bessent to depreciate the dollar unilaterally, perhaps using currency intervention. Or perhaps even default on US debt. On the campaign trail last October, Trump said of Democrats: \u201cI say to the Republicans out there \u2013 Congressmen, Senators \u2013 if they don\u2019t give you massive cuts, you\u2019re going to have to do a default.\u201d<\/p>\n Trump\u2019s dangerous flirtation with a default on US debt reared its head on the campaign trail in 2016. At the time, he told\u00a0CNBC, \u201cI would borrow, knowing that if the economy crashed, you could make a deal. And if the economy was good, it was good. So therefore, you can\u2019t lose.\u201d<\/p>\n In 2020, the\u00a0Washington Post\u00a0reported that the\u00a0Trump\u00a0White House mulled cancelling debt held by Beijing amid trade tensions<\/a>. With the US national debt twice the size of\u00a0Chinese GDP, it\u2019s not hard to understand how much of a financial earthquake that would be.<\/p>\n Such debates play into China\u2019s hands. To be sure, Xi\u2019s Communist Party worries about Trump\u2019s policies that damage the dollar. Along with putting China\u2019s exports in harm\u2019s way, Trump is helping make Beijing\u2019s case for an alternative to\u00a0the dollar<\/a>. <\/p>\n A key Xi initiative has been to internationalize the yuan. The effort has made inroads. But\u00a0Trump\u2019s assault on the dollar\u2019s global standing may accelerate the changing of the guard in currency circles.<\/p>\n