The risks of global debt as Japan struggles with bond market turmoil

The global economy may be facing a seismic shift as cracks begin to appear in Japan’s bond market, sparking fears for heavily indebted nations including the UK and the US. A recent lacklustre auction of Japanese 20-year bonds has sent long-term yields soaring to historic highs, putting pressure on markets already jittery over debt sustainability.

On Tuesday, Japan attempted to sell 1 trillion yen (£5.2 billion) worth of March 2045 bonds. The results were disappointing, with the average bid-to-cover ratio falling to 2.5, the lowest since 2012. This lack of investor appetite pushed the 20-year yield to the highest point this century, further fuelling concerns about Japan’s fiscal health.

Prime Minister Shigeru Ishiba has warned parliament that the debt-laden Japanese government’s financial stability is now “worse than Greece”. This stark assessment follows months of concern over market confidence as Japan grapples with a staggering debt-to-GDP ratio of 235%—far higher than Greece at its 2009 crisis peak. Ishiba’s remarks come ahead of a crucial upper house election where spending promises could further complicate the fiscal picture.

Investors’ reluctance to purchase government bonds reflects deeper unease beyond Japanese borders. Kathleen Brooks, an analyst with XTB, noted that the pressure facing Japan echoes a broader trend of bond traders penalising high-debt nations. Rising costs of borrowing have stalled the era of cheap money, forcing governments to focus more on fiscal consolidation.

The Bank of Japan (BoJ) has also shifted its decades-long policy of economic stimulus through bond purchases. The central bank, owning nearly half of Japan’s outstanding bonds, reduced its purchases this year by 400 billion yen per quarter to combat rising inflation. However, the bond market has struggled to attract buyers, with traditional investors such as life insurers also retreating. The BoJ’s actions have raised debate over whether to further reduce its interventions or maintain stability by continuing substantial monthly purchases.

Beyond Japan, concerns about unsustainable debt levels are intensifying in other developed markets. The US has seen similar pressure, with its government debt-to-GDP ratio at 123% and rising. Questions around fiscal stability—and the potential for a financial crisis akin to the UK’s recent volatility or even “Liz Truss moments”—amplify fears of market unpredictability.

The ripple effects of instability in the Japanese bond market cannot be underestimated. British bonds are often influenced by shifts in US markets, creating a domino effect stemming from American policy volatility. This interconnectedness poses risks as investors grow uneasy with fiscal positions across developed economies.

The next critical moment for Japan is an upcoming auction of 40-year bonds. The results of this sale will reveal whether appetite for Japanese debt remains weak or if cautious optimism can return. With volatility still gripping global bond markets, finance ministers worldwide face urgent calls to address mounting debt and restore confidence.