TOKYO – As Japan staggers out of 2025, its financial markets make for quite a tantalizing split screen.
On one screen, the Nikkei 225 Stock Average is ending the year at all-time highs on optimism that the government can avoid recession. On the other screen, the “bond vigilantes” are pushing 10-year yields to the highest levels since 2007 amid fears about what those efforts might cost.
The price in question comes in two parts. The first is the ¥17.7 trillion ($114 billion) stimulus package Prime Minister Sanae Takaichi is currently unleashing. This fresh spending burst has bond traders in a whirl. It’s probably just the beginning of the “Takaichinomics” largess to come after the economy shrank 2.3% year-on-year in the third quarter.
Takaichinomics may include tax cuts, too. On the campaign trail, Takaichi, who took office in late October, telegraphed reductions in consumption levies. With Japan’s debt-to-GDP ratio already 260%, the fear is that Takaichi might draw unwanted attention from credit rating companies.
In August, two months before Takaichi came along, Japan’s finance ministry asked for a record $220 billion for debt-servicing costs in next fiscal year’s budget. This gets to the bigger cost of short-term stimulus: sharply higher debt payments from Asia’s second-biggest economy.
Liz Truss. Photo: Wikimedia Commons
Not surprisingly, bond traders are buzzing about a “Liz Truss moment” in Tokyo.
The reference here is to the late 2022 debt crisis precipitated by the the UK’s then-Prime Minister Truss.
She tried to sneak an unfunded tax cut past bond traders.
In the extreme market turmoil that followed, a UK tabloid live-streamed a head of lettuce next to a Truss photo to see if it could outlast her premiership.
The vegetable won.
In May, Takaichi’s predecessor Shigeru Ishiba said Tokyo’s deteriorating finances are “worse than Greece.” The comment made global headlines for all the wrong reasons.
Ishiba was trying to make a more nuanced point, aimed at dissuading lawmakers from cutting taxes to juice GDP. He worried that the step might draw credit rating analysts’ attenton to Tokyo’s precarious finances.
Toyko is among the governments that Emre Tiftik, an economist at the Institute of International Finance, highlights when warning that even with “budget deficits still elevated,” some “sovereigns are likely to continue adding to their debt burdens and interest expenses. As a result, investor attention “is increasingly shifting toward government bond auctions and government borrowing plans.”
Japan’s demographic trajectory hardly helps. Its aging, shrinking population features one of the globe’s lowest birthrates. In 2024, Japan’s population shrank by 0.75%, the largest decline since records began in 1968.
Around the time Ishiba was comparing Japan to Greece, a routine May 20 sale of $6.9 billion of bonds maturing in 2045 attracted the weakest demand since 2012. The “tail,” the spread between the average and lowest-accepted price, was the ugliest since 1987. Since then, a series of 20-year, 30-year and 40-year JGBs has been alarmingly undersubscribed.
Part of the problem is how US President Donald Trump’s tariffs are wreaking havoc with US Treasuries and the dollar. That turmoil was one of the key reasons why the Bank of Japan delayed its two-year process of raising rates from zero.
Next week, the BOJ is almost universally expected to resume its rate hike cycle. On December 19, Governor Kazuo Ueda is seen boosting the BOJ’s benchmark by 25 basis points to 0.75%. The bond vigilantes aren’t giving Ueda & Co. much of a choice in the matter, pushing 10-year yield to an 18-year high near 2%.
Reportedly, Ueda has gotten tightening okayed by Takaichi’s Liberal Democratic Party. But after next Friday, all bets may be off. Takaichi’s entire economic strategy is based on a weak yen to support exporters. This requires the BOJ to keep its ultra-loose policies in place – or, at the very least, to slow down the pace of tightening.
Trouble is, the BOJ has been here before. Thanks to the financial chaos surrounding Trump’s trade war, Ueda might find himself in the same position as Toshihiko Fukui, the last BOJ head to bring rates to their current levels.
Between 2006 to 2008, Fukui’s board managed to scrap quantitative easing and hike rates for the first time since the late 1990s. He pushed benchmark rates to 0.5%. Then came the 2008 “Lehman Shock,” and with it a return to QE.
As the dollar’s slide pushes the yen higher, there’s growing pressure on Ueda to stop hiking rates. But this, too, is fueling a debate about the pros and cons of quantitative easing over the last 24 years.
Even some senior officials in Takaichi’s LDP are realizing that a quarter century of zero rates has backfired. In this way, the plunge in the yen over the last decade is now coming back to haunt Tokyo.
“A weaker yen means it takes more yen to buy the same amount of food or oil as before,” says Richard Katz, author of The Contest for Japan’s Economic Future. “Imported inflation was a major factor in falling real wages over the past three years and has led to political pressure to try to keep the yen from weakening even more.”
An undervalued yen also deadened lawmakers’ urgency to level the playing field and increase competitiveness. It took pressure off corporate CEOs to innovate, restructure, disrupt and boost productivity. It’s among the reasons Japan Inc. is watching with alarm as Chinese electric-vehicle maker BYD and artificial-intelligence upstart DeepSeek shake up their respective industries, in the way Japan Inc. might’ve done in the 1980s.
In a recent assessment of Japan’s economy, the International Monetary Fund argues that “Japan’s total factor productivity growth has been slowing for a decade and has fallen further behind the United States. A steady decline in allocative efficiency since the early 2000s has been a drag on productivity, and likely reflects an increase in market frictions.”
What’s more, the IMF notes, “Japan’s ultra-low interest rates may have allowed low-productivity firms to survive longer than they otherwise would have, delaying necessary economic restructuring. Reforms aimed at improving labor mobility across firms would help improve Japan’s allocative efficiency and boost productivity.”
With Japan now skirting recession, it’s not clear how much latitude – or political courage – Takaichi will have as she attempts to reboot the economic policies of her mentor, Shinzo Abe. Fifty days in, Takaichi has said little about cutting bureaucracy, modernizing labor markets, rekindling innovation, increasing productivity, empowering women’s productivity and restoring Tokyo’s place at the center of global finance.
With Japan now skirting recession, it’s not clear how much latitude – or political courage – Takaichi will have as she attempts to reboot the economic policies of her mentor, former Prime Minister Shinzo Abe, shown sitting with her in 2014. Photo: Toshifumi Kitamura / EPA
Yet, the BOJ will come into conflict with Takaichi’s government if it tries to continue hiking rates in 2026. In part, that’s because Japan’s 3% inflation rate is outpacing both GDP and wage gains. This has Shigeto Nagai, head of Japan research at Oxford Economics, worried about a “mildstagflation threat.”
As Nagai puts it, “if inflation doesn’t decline to 2% as smoothly as projected, consumption will remain subdued as real incomes stagnate. A weak yen or other supply shocks may prolong cost-push inflation. Also, supply constraints from labor shortages may be more serious than assumed, raising inflation through the passthrough of wage costs and a tighter output gap.”
Another problem is Japan’s chronically low productivity. Its worker efficiency rate, for example, is in the bottom one-third of Organization for Economic Cooperation and Development members. This means that any move by Japan Inc. to hike wages in the year ahead could just exacerbate inflation – and create the conditions for more tightening.
None of this augurs well for Takaichi’s longevity as leader. Opinion polls show consumers are already fed up with inflation – and reining in household spending as a result. The fact that Takaichi, right out of the gate, is focused more on a war of words with China over Taiwan than on economic retooling suggests she’ll be yet another short-timer.
Japanese leaders don’t tend to last long. Over the last two decades, the vast majority of prime ministers have served for just 12 months. That’s how long Takaichi’s predecessor got. Ishiba was Japan’s 10th prime minister since 2006. Eight came and went within 365 days. And with Asia’s biggest revolving door spinning again, the clock is already ticking for Takaichi’s government.
Like Abe early on, Takaichi is enjoying a decent boost in her approval rating. Part of the support is based on the milestone she represents: Japan’s first female prime minister. Also, her talk of taking “Abenomics” to the next level excited the masses.
Yet memories are often short in politics. The extent to which Abenomics backfired on Japan is a case in point. Takaichi marks the fifth government since 2012 that’s planned to prioritize a weak yen over bold steps to increase competitiveness. Hindsight shows how aggressive QE took the pressure off politicians and chieftains to reform and raise Japan’s economic game.
Getting under the economy’s hood and implementing supply-side upgrades would pay greater dividends than an ultra-low rate. It might also buy Takaichi more time in office than the usual 12 months.
