The U.S. Treasury market has found itself back in the danger zone, and this time the next source of pressure may be coming from Tokyo rather than Washington.
Long-term U.S. Treasury yields have climbed close to multi-decade highs, reviving concerns about borrowing costs, stock-market valuations and the broader financial conditions facing the U.S. economy. Treasury Secretary Scott Bessent has already taken steps to improve liquidity in the long-end of the bond market, including doubling the pace of long-term Treasury buybacks last month.
But the market is still struggling.
And a new potential threat is emerging from Japan.
Japan is the largest foreign holder of U.S. government debt, with roughly $1.1 trillion of Treasurys on its books. For decades, Japanese institutions and investors have had a strong incentive to put money overseas because domestic Japanese interest rates were exceptionally low.
That incentive is now changing.
Japan’s 10-year government bond yield has climbed toward 3%, a level not seen since 1996. For investors accustomed to years of near-zero domestic returns, that is a major shift. Japanese pensions, insurers, banks and other institutions can increasingly earn attractive returns without taking the currency and interest-rate risks associated with investing in foreign bonds.
That could eventually mean less Japanese demand for U.S. Treasurys.
And that matters because the Treasury market needs a steady supply of buyers to absorb Washington’s enormous borrowing requirements.
The issue is not simply whether Japan sells billions of dollars of Treasurys tomorrow. The larger concern is what happens if Japanese investors gradually become less willing to buy U.S. debt in the first place.
A decline in demand can force the market to offer higher yields to attract new buyers.
Higher Treasury yields then spread through the financial system.
Mortgage rates can rise. Corporate borrowing becomes more expensive. Credit conditions tighten. And the discounted value of future corporate earnings falls, potentially putting pressure on stock valuations.
That is why the latest bond-market weakness is being watched far beyond fixed-income desks.
The immediate numbers are already uncomfortable.
The U.S. 30-year Treasury yield has moved back toward its highest level since 2007, while long-dated borrowing costs remain elevated despite the Treasury’s efforts to improve market functioning. Yahoo Finance reports that the Treasury has effectively had to respond to a market that remains unusually sensitive to supply, inflation and fiscal concerns.
But Japan presents a different kind of challenge.
Tokyo is dealing with its own currency problem.
A weaker yen can encourage Japanese authorities to intervene by buying yen and selling dollars. If those dollar holdings have to be raised through transactions involving U.S. government securities, Treasury selling pressure could increase.
That sounds like a recipe for further trouble.
Yet the reality is more complicated—and, for now, less alarming.
Japanese investors sold a net $71 billion of U.S. government debt through June, according to Treasury data cited by Yahoo Finance. Nearly all of that selling, about $69 billion, involved short-term Treasury bills that mature within a year.
Sales of longer-dated Treasury notes and bonds were only around $3 billion.
That distinction is crucial.
Short-term bills are less directly connected to the long-term interest rates that drive mortgage costs, corporate financing and stock valuations. The market can absorb changes in bill ownership without necessarily producing the same shock as a major foreign liquidation of 10-year or 30-year debt.
So the nightmare scenario has not happened.
But Washington is clearly preparing for the possibility that pressures could become larger.
One of the most interesting tools in that effort is the Federal Reserve’s Foreign and International Monetary Authorities, or FIMA, repo facility.
The facility allows foreign central banks to temporarily exchange Treasury securities for dollars rather than selling those Treasurys directly into the market. In practical terms, that gives countries such as Japan another way to raise dollar liquidity without dumping government bonds on an already stressed market.
The mechanism became particularly relevant after the U.S. and Japan jointly intervened in currency markets on July 31 to support the yen. Japan subsequently indicated that it intended to use the FIMA facility in the future.
Bessent has also called for an expansion of the facility.
That request is revealing.
It suggests U.S. policymakers are not simply responding to one isolated market event. They are considering how Japan’s changing monetary environment could interact with the Treasury market over a longer period.
For decades, Japan’s ultra-low interest-rate regime effectively helped channel global capital toward higher-yielding foreign assets.
Now the trade is changing.
If Japanese government bonds offer increasingly attractive returns at home, the economic justification for sending capital abroad becomes weaker.
And that does not require Japan to become an aggressive seller of Treasurys.
A reduction in future buying can be enough to change market dynamics.
Imagine a Treasury auction in which one of the world’s largest pools of potential buyers becomes less enthusiastic. The U.S. government still needs to borrow. The bonds still need buyers. The price adjusts until investors are compensated enough to accept the risk.
That compensation comes in the form of higher yields.
For Bessent, this is precisely the problem he wants to prevent.
The Treasury secretary has emphasized that the best way to handle a financial crisis is to prevent it from developing in the first place. The administration therefore has an incentive to maintain market liquidity and prevent foreign-exchange turbulence from triggering a second wave of Treasury selling.
The danger is compounded by America’s own fiscal trajectory.
The United States continues to run large deficits, meaning Washington must regularly issue enormous amounts of debt. The challenge becomes more difficult if demand weakens at the same time supply remains high.
This is why the bond market has become one of the most important places to watch for signs of financial stress.
A rising yield is not automatically a crisis. Strong economic growth can naturally push rates higher. Inflation can also require higher returns.
But when yields rise because investors demand a greater premium for absorbing government debt, the implications can be more serious.
And Japan could become an increasingly important part of that equation.
For now, Japanese investors have not unleashed a major long-duration Treasury liquidation. The most significant selling has been concentrated in short-term securities.
That is the good news.
The bad news is that Japan’s domestic bond market is changing rapidly.
A country that once had almost no yield at home is beginning to offer investors a meaningful return.
That could gradually redirect one of the world’s largest pools of capital.
And if that shift happens while the United States continues borrowing at an extraordinary pace, Treasury yields may face another leg higher.
The bond market has already entered the warning zone.
Japan could determine how much worse it gets.