[Yen Carry] The Shadow Cast by Japan’s Expansionary Fiscal Turn Amid Bond Market “Frenzy,” Warning Bells of a ‘Truss Shock’

The End of Japan’s Ultra-Low-Rate Era and the Rising Burden of Sovereign Debt Servicing
Markets Send a Warning to the Takaichi Cabinet’s Mega-Stimulus Push
Parallels Drawn With Former UK Prime Minister Liz Truss, Ousted Over Unfunded Tax Cuts

As Japanese government bond yields surge, heightening risk aversion across global financial markets, controversy is intensifying over Prime Minister Sanae Takaichi’s expansionary fiscal stance. While the Japanese government has moved to play down concerns, critics argue that the combination of mounting sovereign debt and unfunded tax cuts and spending increases is amplifying market unease at a time when policy rate hikes have brought the ultra-low-rate era to an end. With the aftershocks of yen carry trade unwinding still reverberating and the fiscal strain on Japan’s public finances coming into sharper focus, foreign media and global investors are increasingly voicing warnings over the prospect of a “Japan-style Truss shock.”

Japanese Finance Minister: “Market Participants Should Not Be Alarmed”

On January 21 (local time), Japanese Finance Minister Satsuki Katayama said in an interview with Bloomberg TV that “since the launch of the Takaichi cabinet in October last year, Japan’s fiscal policy has been consistently responsible and sustainable, and the data show that it has not been expansionary,” adding that she hoped “market participants will remain calm.” She cited Japan’s relatively low reliance on government bond issuance over the past 30 years, rising tax revenues, and the smallest fiscal deficit among the Group of Seven as evidence. The remarks were widely seen as an attempt to quell concerns that expansionary fiscal pledges ahead of an early general election could undermine fiscal discipline.

Earlier, on January 19, yields on Japan’s 30- and 40-year government bonds surged by more than 25 basis points (1 basis point = 0.01 percentage point), marking the largest swing since April last year, when U.S. President Donald Trump’s announcement of reciprocal tariffs rattled global markets on what became known as “Liberation Day.” As turbulence in Japan’s bond market pushed up yields on U.S. 10-year Treasurys, U.S. Treasury Secretary Scott Bessent also stepped in to calm markets. “The spike in Japanese government bond yields is affecting U.S. markets as well,” he said, adding that he had contacted his Japanese counterparts and that “they will begin making statements that help stabilize the market.” Katayama’s comments followed shortly thereafter.

However, experts argue that verbal intervention alone is insufficient to restore confidence. Katsutoshi Inadome, chief strategist at Sumitomo Mitsui Trust Asset Management, said, “Given the strength in futures markets, buying interest may emerge the following day, but unless the government shifts away from its expansionary fiscal policy, a full market rebound will be difficult.” He added that while Katayama’s remarks may have some effect, “without revisions to the proposed consumption tax cuts or concrete follow-up measures to secure funding, mere words will not be enough to calm the market.”

Rising Interest Costs Emerging as a Constraint on Future Policy Spending

Japan’s sovereign debt currently exceeds 240% of gross domestic product, amounting to approximately $7.5 trillion. This is nearly nine times the level of South Korea’s government debt and is widely regarded as the most severe among advanced economies, even after accounting for economic scale. Over the past two decades, Japan expanded public spending through deficit financing under an ultra-low interest rate environment. When borrowing costs were effectively negligible, the government freely issued bonds to finance larger expenditures. This policy orientation was epitomized by “Abenomics,” the stimulus program launched during former Prime Minister Shinzo Abe’s second term beginning in 2012, centered on aggressive fiscal expansion through infrastructure investment.

That era effectively came to a close last year with the start of policy rate hikes. The impact was immediate. When the Bank of Japan raised its policy rate in August last year, yen carry trade positions were rapidly unwound, sending shockwaves through equity markets in New York and across Asia. As rates rose from 0% to 0.25% and the yen strengthened, overseas investors moved to repay loans and reduce positions to avoid foreign exchange losses. Japanese retail investors, often referred to as “Mrs. Watanabe,” were no exception. Market participants increasingly view the yen carry trade as neither viable nor stable, given the risk of renewed market convulsions even from modest policy shifts.

While attention at the time focused on the explosive nature of the carry trade unwinding, the period also marked the point at which the structural burden of higher interest rates on Japan’s fiscal position began to materialize. The compounding interest costs on the principal of government debt effectively opened the floodgates. According to Japan’s Ministry of Finance, over the past 20 years the government spent roughly $470 billion annually on interest payments at interest rates ranging from 0.8% to 1.4%. As rate hikes gained momentum, the ministry raised the assumed interest rate for fiscal year 2025 to 2%, pushing annual interest payments to approximately $670 billion.

Crucially, this appears to be only the beginning. The Ministry of Finance projects that interest expenses will continue to climb rapidly in the coming years as rates rise further. Estimates released in January show that by fiscal year 2028, annual interest payments are expected to reach about $1.02 trillion, an increase of roughly $350 billion from fiscal year 2025, based on an assumed interest rate of 2.5%. Should rates rise faster than anticipated or remain elevated for an extended period, interest costs are likely to emerge as a key constraint, crowding out other policy expenditures.

Concerns are also growing over the potential spillover of Japan’s fiscal risks into global markets, particularly the United States. Ken Griffin, founder of hedge fund firm Citadel, said that “the sharp decline in the value of Japanese government bonds is a clear warning to the United States,” adding that it “sends a message to Congress that fiscal reconstruction is necessary.” While noting that the U.S. can sustain deficit spending for now due to its vast wealth, he warned that delaying fiscal reform would ultimately necessitate more painful adjustments. U.S. fiscal conditions are already showing signs of strain. In May last year, credit rating agency Moody’s downgraded the U.S. sovereign credit rating by one notch from Aaa to Aa1, citing widening fiscal deficits, rising government debt, and mounting interest burdens.

Bloomberg “Takaichi’s Stimulus Is Amplifying Market Volatility”

Given the scale of Japan’s debt burden and its potential impact on global financial markets, foreign media have also issued warnings over Prime Minister Takaichi’s expansionary fiscal agenda. On January 21, German business daily Handelsblatt described the surge in Japanese government bond yields as a state of “frenzy,” drawing comparisons between Takaichi and former UK Prime Minister Liz Truss, whose unfunded tax cuts triggered market turmoil and ultimately forced her resignation. The paper highlighted Takaichi’s proposal to exempt food from the consumption tax for two years ahead of elections, arguing that it raises “serious questions about fiscal sustainability.” Quoting a U.S. asset management executive, it added that “the sharp volatility in Japan’s bond market shows that investors are increasingly mindful of a ‘Japan-style Truss shock.’”

Bloomberg also characterized Takaichi’s aggressive fiscal stance as a successor to Abenomics, warning that it could exacerbate market volatility. Citing the yen’s recent weakness to around 159 per dollar and government bond yields surpassing 2.275%, Bloomberg cautioned that “large-scale fiscal expansion focused on infrastructure, semiconductors, and defense, combined with tax cuts such as consumption tax deferrals, may support equity rallies in the short term, but is creating new sources of instability in interest rates and foreign exchange markets.” It added that “unlike Abenomics, which was implemented under a low-rate, quantitative easing environment, Takaichi’s fiscal expansion is starting in a fundamentally different setting of rising interest rates, heightening market concerns.”

Within Japan, criticism is also mounting over Prime Minister Takaichi’s proposed 2026 budget. While the government is emphasizing proactive fiscal policy, critics argue that the lack of concrete funding measures risks further inflating the national debt. Nikkei said the plan “lacks a perspective of fiscal responsibility toward future generations,” while Asahi Shimbun reported growing unease within the ruling Liberal Democratic Party over the prime minister’s policy direction. Yomiuri Shimbun and Kyodo News likewise warned that the risk of financial market disruption is increasing. Analysts note that the persistence of yen weakness despite rate hikes and the continued rise in market interest rates underscore how Takaichi’s expansionary fiscal stance is increasingly perceived as a source of instability.