Fiscal fireworks: How debt is rewriting the rules for the United States and Japan

The world is no stranger to a debt crisis. It’s been a feature of financial markets for decades—from Latin America in the 1980s to the Asian Financial Crisis in the late 1990s. Although emerging markets are more prone, the phenomenon has spread to developed markets. That used to be unfathomable. But starting with the Eurozone in the wake of the Global Financial Crisis (GFC), debt crises have become more frequent. What’s worse? It’s engulfing some G-7 nations—the custodians of the world’s largest capital markets. In just the past few years, the United Kingdom faced a gilt crisis in 2022, and the French snap parliamentary election in 2024 sent bonds spiraling. Could Japan or even the United States be next? 

True doomsdayers would look at the accelerated yen depreciation toward 160 versus the U.S. dollar, the sell-off in Japanese Government Bonds (JGBs) and continued weakness in the greenback, and argue they’re early signs of a debt crisis. Although the market drivers look similar on the surface, and even to some extent rhyme with past iterations, it’s safe to say the boiling point has not yet arrived.

The poster child of too much debt

Borrowing has outpaced spending for the majority of countries. And Japan has been its poster child with a debt-to-GDP ratio of 237%, followed by European nations of Greece (151%) and Italy (135%), which are still dealing with the legacy of their sovereign debt crisis some 15 years ago. The United States sits at 121%. The assumption of underlying growth and the sheer ability to print money to service that debt was doing the heavy lifting in assuaging concerns. But the markets have become severe critics. And now, no one is immune.

Take the U.K. gilt crisis of 2022, when its 10-year surged almost 140 basis points in less than a month. Or France’s snap parliamentary election in 2024, when President Emmanuel Macron aimed to consolidate his party’s seats. It sent French sovereign debt (OATs) to its widest spreads versus the German bund since the Eurozone crisis more than a decade prior. The political and spending risks loom so large that the market punishes borrowers for any signs of fiscal irresponsibility.

Rhymes with a crisis

Something similar is unfolding in Japan. Prime Minister Sanae Takaichi was elected to office with plans to unleash spending and stimulate growth in areas like defense and technology. But Japan is already spending far more than it should (when taking into account debt-servicing costs), while struggling with a domestic affordability crisis. Given the elevated debt-to-GDP ratio, long-term yields should be higher, to say nothing of the inflation dynamics. That’s where signs of stress would traditionally manifest, but the Bank of Japan’s ongoing bond purchases have artificially suppressed the market. On the one hand, Japan needs to let yields rise in line with fundamentals, but in doing so, it could spark a debt crisis and further burden the Bank of Japan. That leaves the unrelenting weakening of the yen as the only avenue to price fiscal risk.

Takaichi then announced tax cuts on food to help aid Japan’s affordability issue and a snap lower-house election—something that could improve her party’s coalition, making legislation easier to pass. Or hurt it. Sound familiar?

The markets think so. Whereas the debt concerns have been manifesting through continued yen depreciation for some time, a four-day, ~40-basis-point rise in long-end JGB yields off Takaichi’s announcement jolted investors. By comparison, French bond spreads widened by about the same margin over the course of six months after its snap parliamentary election was called.

Rumors of potential currency intervention have brought brief respite, but it’s clear that the markets are issuing a warning: Taking on more debt comes with a cost.

Turn on the taps

Government spending is a tried-and-true method to boost growth. American policymakers have relied on spending programs like the CARES Act post-COVID or the New Deal in response to the Great Depression as stimulus for years. Spending helps, but it can also hurt. Take the economic boom of the 1980s, when increased defense spending, tax cuts and entitlement growth drove a doubling in nominal GDP growth. It also came with a $2.3 trillion increase in debt. In debt-to-GDP terms, it marked a 22% jump.

The trick is to grow faster than the price tag. The United States has big plans for an AI infrastructure buildout, defense funding and tax cuts amid other policies. But the debt-servicing costs are large. And passing budgets are getting harder. It’s why government shutdowns or the threat of them have become seemingly more common occurrences. The political ramifications of the fiscal issue have traditionally been more dramatic than the market consequences.

Outside of the brief resurgence of the “Sell-America” trade, foreign appetite for U.S. assets hasn’t meaningfully changed. Instead, relative growth and interest rates remain the main driver of the dollar. And expectations for American growth remain resilient, while the market is pricing more rate cuts from the Federal Reserve than it’s likely to deliver. Interest rate differentials have already moved in favor of the United States since the start of the year. This means the recent sentiment-driven bout of dollar weakness will be temporary and eventually stabilize as the U.S. economy picks up steam throughout the year.

But the debt burden is becoming a more tradeable factor. As the dollar and yen start to swoon, it’s prompting more flows into assets like gold. With central bank purchases driving the precious metal’s >90% rally since the start of 2025, investors can participate while diversifying their portfolios with an alternative safe haven and hedge against currency risk.

Are we there yet?

It’s not a crisis—yet. But it is a notable repricing in the markets that’s taking its tune from a rapidly devolving fiscal situation.

Although government debt piles are rising, Japan may be closer to the tipping point than the United States. Japan has generated stronger nominal growth amid a reflating economy, but still faces structural issues like a demographic shift and inflationary pressures. On the other hand, the United States continues to grow, and prices have stabilized. Whereas the Bank of Japan is chasing rate hikes in a three-year delayed catch-up cycle, the Fed has an easing bias. JGBs and the yen have experienced capital flight, but Japanese equities are surging to all-time highs. It stands in stark contrast to the “Sell-America” trade, when the dollar, Treasuries and the stock market all sell off at once. Even as questions remain around the dollar’s traditional qualities, it still remains by far the world’s reserve currency.

Diversification is still the key to navigating these markets. Infrastructure and gold remain assets that some investors consider for portfolio diversification as global growth remains on track and traditional assets become more volatile.