U.S. Treasury Secretary Scott Vessenet has urged Japan to simultaneously raise interest rates and ensure fiscal sustainability. Following a joint U.S.-Japan intervention in the foreign exchange market at the end of July, the yen's value fell back to around 160 yen per dollar, indicating that market interventions alone may not be sufficient to reverse the yen's decline.
Meanwhile, Japan's 10-year government bond yield surged to 3%, marking its highest level in 30 years. To prevent further yen depreciation, the Bank of Japan (BOJ) would need to raise policy rates, but this could increase the government's interest burden.
According to Japan's public broadcaster NHK, Erin Brown, the U.S. Treasury's Deputy Assistant Secretary for International Affairs, stated that Vessenet met with BOJ Governor Kazuo Ueda and Finance Minister Shunichi Suzuki during the G20 finance ministers and central bank governors meeting. Brown noted that Vessenet emphasized the importance of Japan clearly presenting its plans for fiscal sustainability and the path for interest rate hikes to the market.
Finance Minister Suzuki confirmed the meetings, marking the first face-to-face discussions since the U.S.-Japan coordinated intervention at the end of July. After the talks, Suzuki told reporters, "An orderly yen exchange rate is essential for the stability of global financial markets, and our cooperative response contributes to this common goal." He added that he stressed the need to balance a strong economy with fiscal sustainability and believed he gained understanding on this point.
However, he clarified that discussions on specific methods for interest rate hikes were left to the BOJ. Following the intervention on July 31, the yen had briefly risen to around 155 yen per dollar but has since retreated to around 160 yen.
In a CNBC interview on July 31, Vessenet expressed confidence that the Japanese government and BOJ would take measures leading to a stronger yen. He noted that the market is already reflecting the possibility of early rate hikes by the BOJ, stating, "I have information that the market does not possess." Regarding foreign exchange market interventions, he remarked, "We cannot influence the natural equilibrium level; all we can do is send signals."
Vessenet's call for changes in Japan's monetary and fiscal policies stems from concerns that instability in the yen and Japanese bond market could spill over into the U.S. market. The Nihon Keizai Shimbun (Nikkei) reported that the U.S. has been wary not only of yen depreciation but also of the risk that rising long-term interest rates in Japan could push U.S. rates higher.
If the BOJ raises policy rates, the interest rate differential between the U.S. and Japan would narrow, potentially stabilizing the yen. Conversely, if the Takahichi government’s aggressive fiscal policies lead to increased fiscal instability and a surge in Japanese long-term interest rates, domestic institutional investors, such as life insurance companies, may reduce their investments in U.S. Treasury bonds and redirect funds back to Japan. A decrease in demand for U.S. Treasuries could lead to higher U.S. bond yields, which would also burden American households and businesses. Ultimately, the U.S. request can be interpreted as a call for Japan to raise policy rates in a predictable manner while preventing a surge in long-term rates stemming from fiscal instability.
On the same day, the benchmark 10-year government bond yield in the Tokyo bond market reached 3.000% during trading. This marks the first time it has exceeded 3% since September 1996. According to Nikkei, financial markets are predicting a greater than 90% chance that the BOJ will raise rates at its monetary policy meeting on September 17-18. There is also a 70% likelihood of a 0.5 percentage point increase by December. Expectations that the BOJ will not stop at a single hike in September but will continue to raise rates quickly have fueled the rise in long-term interest rates.
While policy rates and 10-year bond yields are different in nature, they are not unrelated. If expectations of higher yields due to the BOJ's rate hike outlook arise, investors may seek to sell existing low-yield bonds. An increase in bond supply can lead to falling prices, which in turn raises yields, as bond prices and yields move inversely. The 10-year yield is determined not only by monetary policy but also reflects inflation, economic growth rates, and fiscal outlooks.
However, the rise in long-term interest rates on this day was not solely influenced by the BOJ's rate hike expectations. Nikkei noted that Federal Reserve Chair Kevin Warsh's comments at the Jackson Hole meeting on August 28, expressing uncertainty about inflation moderation and stating, "There are things we need to do," contributed to the rise in U.S. 10-year Treasury yields to their highest level since January 2025, at around 4.7%. Additionally, rising international oil prices due to instability in the Middle East have heightened inflation concerns.
Concerns over Japan's fiscal expansion are also growing. The budget requests from various ministries for the 2027 fiscal year have surged to a record high of around 143 trillion yen, prompting caution regarding the Takahichi administration's aggressive fiscal policies, which have fueled bond sell-offs. The long-term interest rate, which was around 1.6% when Prime Minister Takahichi took office last October, has reached 3% in less than a year.
The question remains whether the yield rising to 3% can revive demand for government bonds. In a recent auction conducted by the Japanese Ministry of Finance, the highest accepted yield for 10-year bonds was 3.011%, surpassing 3% for the first time since August 1996. As buying interest emerged in response to the yield level, the market assessed that "it was not as poor as feared."
However, if investors expect that rising yields due to fiscal instability will continue, they may delay purchases of government bonds to avoid potential losses from falling prices. Ryutaro Kimuura, chief bond strategist at BNP Paribas Asset Management, told Nikkei, "A long-term yield of 3% appears attractive for investment, but concerns over expansionary fiscal policy are making investors cautious."
The market is also keeping the possibility of further increases in Japan's long-term interest rates open. A recent emergency survey of market experts by Nikkei indicated that while the forecast for this year's peak is generally around 3.0-3.15%, there are projections that it could rise to 3.5% or even around 4% next year. In a situation of rising prices, if the government continues to expand fiscal policy, the pressure for additional rate hikes from the BOJ will increase, and combined with fiscal instability, long-term interest rates could rise further.
Ultimately, Japan faces the dual challenge of raising policy rates to prevent yen depreciation while restoring fiscal credibility to avoid a surge in long-term interest rates and an increased interest burden on the government.
* This article has been translated by AI.
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