The Sequel: Japanese Debt Fears Are Back!

Another day, another flurry of debt concerns—this time centered on Japan, where bond yields spiked as investors grappled with talk of the government potentially getting more stimulus-minded after Sunday’s upcoming upper house election. Sure, Japan’s gross government dept topping both 200% of GDP and one quadrillion yen might not have caused problems before now, but with rates now higher today, many claim the chickens are finally, after many years coming home to roost. But a quick look at public finances shows this is a false fear, and Japan’s debt isn’t a ticking timebomb for stocks or bonds.

This is actually Japan’s second bond market freakout this year. The first struck in May, when Prime Minister Shigeru Ishiba—seemingly posturing for the upcoming election—called Japan’s fiscal situation “worse than Greece” and warned higher deficits would cause trouble. At the time, it looked to us like he was trying to combat the opposition Constitutional Democratic Party of Japan’s (CDPJ’s) polling ascent, using debt fears to take the shine off their proposed fiscal stimulus. Yields eventually settled down—alongside global rates—as widely feared bond auctions went off without a hitch. But now polls indicate the CDPJ is in pole position to take a majority in this weekend’s election for the upper chamber of parliament, potentially putting a sales tax cut on the agenda and cranking up the deficit. Now 10-year and 30-year yields are about where they were in May, basically an all-time high for the latter.

Look, Japan’s debt is high. And we don’t think it is beneficial for any country to pile on debt endlessly. Doing so can redirect resources from the private sector and interfere with the optimal allocation of capital, which can hamstring growth. We also don’t think Japan benefited tremendously from the repeat fiscal “stimulus” that pushed debt way, way up since the Nikkei Bubble burst 35 years ago. That spending didn’t prevent Japan’s infamous lost decades.

But philosophical debates about the wisdom and benefits of higher spending and tax cuts aren’t the issue here. The question is simple: Is Japan on the brink of a debt crisis?

We don’t think so. Most talk today centers on the amount of debt outstanding, which is eye-popping. But total debt, whether in yen or relative to GDP, tells you little. The government doesn’t have to pay all that debt at once. It just has to pay interest and refinance maturing principal. And it does so not with GDP, which is the annual flow of economic activity, but with tax revenue. So if a country has high debt, but that debt doesn’t break the bank, there generally isn’t a problem.

So it is with Japan. The Ministry of Finance may have added several hundred trillion yen’s worth of debt over the last 15 years, but interest payments have fallen a bit over that span. Japan spent about ¥9.8 trillion on interest in 2010. Last year, it spent just over ¥9.7 trillion. Payments fluctuated in the interim, both higher and lower, but adding debt hasn’t amounted to piling on interest. Meanwhile, tax revenues nearly doubled. As a result, interest payments’ share of tax revenues has almost halved.

Exhibit 1: Japan’s Interest Burden Is Easing

Source: FactSet, as of 7/15/2025.

Sooooo … how did this happen? Basically, you can thank the Bank of Japan (BoJ). Through negative short-term interest rates and an artificially low 10-year yield target, the BoJ pulled interest rates across the entirety of the yield curve near zero for most of the 2010s and early 2020s, allowing the government to issue and refinance maturing debt at rock-bottom rates. Its quantitative easing (bond buying) and yield curve control (long-term rate fixing) programs also put about half Japan’s debt stock on the BoJ’s balance sheet, limiting the supply for normal investors and further reducing rates. We aren’t calling this wise monetary policy—flattening the yield curve made it difficult for banks to lend profitably, and we think all this monetary “stimulus” hampered growth as a result. But it made Japan’s debt very, very cheap.

No, rates aren’t near zero anymore. But by global standards, they are still quite low. The 30-year is just north of 3.0%, while the 10-year is just over 1.5%.^[i] Neither will break the Ministry of Finance as it continues issuing and servicing debt. Rather, we think this is a return to normal. For many years, Japan’s bond markets didn’t react to fiscal policy talk because the BoJ was doggedly pegging long rates. But yield curve control ended in March 2024, letting rates fluctuate with the market. Short-term volatility, normal in bond markets, is back. It is seemingly just taking investors a while to get used to it. Plus, debt fears are raging globally this year, and Japan is an easy target.

As for fiscal policy moves, this will likely play out as these things always do. Politicians will debate. Deficit hawks will have their say. Those who argue cutting consumption taxes will free up more spending and therefore growth will have their say. There will be haggling and horse trading, and markets will probably wobble on news in the short term but continue moving on supply and demand in the long term. And for better or worse, Japanese bond supply is pretty constrained due to the BoJ’s purchases, which probably keeps yields from running away even if deficits rise over time—which they aren’t guaranteed to, given “unfunded” tax cuts often don’t have the effect feared.

Markets move most on how reality unfolds relative to expectations over the next 3 – 30 months. No one can know how Japan’s finances evolve in the long run, but debt isn’t likely to suddenly become unaffordable within that window. The potential for positive surprise seems quite high to us.