Rising Yields, Soaring Yen: why Japan’s fiscal crisis isn’t sinking its currency

Japan is currently grappling with significant fiscal challenges, highlighted by Prime Minister Shigeru Ishiba's recent statement to parliament that the country's fiscal situation is worse than Greece's during its 2010 crisis. This alarming comparison has intensified scrutiny of Japan's debt structure; however, the yen has been rising.

Japan’s debt crisis: A growing concern

Japan's public debt is among the highest globally, with a debt-to-GDP ratio exceeding 260%. As of December 2024, the central government's long-term debt stood at approximately ¥1,136 trillion, with local governments adding another ¥179 trillion, bringing the total to around ¥1,315 trillion.

Historically, Japan has managed this massive debt burden through ultra-low interest rates and the Bank of Japan’s (BoJ) yield curve control (YCC) policy. However, recent monetary policy shifts have driven yields higher, escalating the cost of debt servicing.

Adding more fuel to the fire, on Tuesday Japan's 20-year government bond auction experienced its weakest demand since 2012. This reflects investor concerns over Japan's fiscal health and the BOJ's tapering of bond purchases. Longer-term bonds have also been affected. The 30-year yield has risen to 3.19%, and the 40-year yield reached a record high of 3.61%. These increases indicate a significant shift in investor sentiment and a re-evaluation of the risks associated with Japanese government bonds.

Japanese 30-year bond yields, daily chart

(Past performance is not a reliable indicator of future results)

Impact on the yen: safe haven demand trumps fundamentals

In theory, the rising yields and fiscal concerns should exert downward pressure on the Japanese yen. However, the currency has been steadily rising since last week. The chart below shows the performance of the yen against a basket of currencies, which is up 2.5% since May 14.

(Past performance is not a reliable indicator of future results)

The move seems counterintuitive but there are several factors at play. In times of global financial uncertainty, the Japanese yen often benefits from its long-standing status as a safe-haven currency. Recent events such as the U.S. credit rating downgrade and renewed volatility in global bond markets have led investors to seek refuge in traditionally stable assets, including the yen.

Another factor supporting the yen is capital repatriation by Japanese institutional investors. With bond yields rising in countries like the U.S. and the UK — and volatility increasing — Japanese pension funds and insurers are bringing funds back home. This flow of capital into Japan boosts demand for the yen, putting upward pressure on the currency even if domestic fundamentals are shaky.

Expectations around the Bank of Japan’s policy are also playing a role. While the BoJ has long maintained ultra-loose monetary policy, rising inflation and bond market disruptions have fuelled speculation that it may shift to a more hawkish stance. Even modest expectations of rate adjustments can cause traders to unwind short positions in the yen, further driving its strength.

Lastly, it's important to remember that currency movements are relative. While Japan has fiscal issues, other major economies are also facing economic and monetary headwinds. In that context, the yen may appear comparatively attractive. So, while Japan’s fiscal worries are real, global investors are currently weighing broader risks and finding reasons to hold the yen — at least in the short term.

Conclusion

While Japan’s fiscal woes are serious and escalating, the yen’s recent appreciation highlights the nuanced nature of global currency markets. Safe-haven flows, repatriation of capital, and shifting policy expectations are outweighing domestic weaknesses — at least for now.

USD/JPY technical analysis

The USD/JPY pair has been locked in a downtrend for eight sessions, erasing gains seen earlier in the month. The dollar's recent weakness — fuelled by growing concerns about the U.S. economic outlook — has added to this downward pressure.

On Thursday, the pair attempted a modest recovery from its intraday low. While the broader bias remains bearish, a break above resistance at 144.40 could spark short-term buying interest. However, without a significant reversal in USD sentiment, gains are likely to be capped near 145.50.

USD/JPY daily chart

(Past performance is not a reliable indicator of future results)