This article first appeared in Forum, The Edge Malaysia Weekly on August 10, 2026 - August 16, 2026
At the end of July, the yen fell to the lowest level against the US dollar in 40 years, touching at one point 164 to one USD. Some analysts think that this was due to the differential between the US and Japanese interest rates, but the US Federal Reserve has kept interest rates unchanged, while Japanese sales of US bonds to support the yen has resulted in US long-term bonds tending higher.
On July 31, US Treasury Secretary Scott Bessent announced coordinated US-Japan currency intervention for the first time since 1998, using the Fed’s Foreign and International Monetary Authorities (FIMA) Repo Facility, which is capped at US$60 billion. As a result of this unprecedented joint intervention, the yen bounced back to 155 and had been trading around 157 per dollar so far last week. Official data on Japanese market intervention is lagged, but market estimates are that Japan’s latest yen buying intervention, which began on July 30, totalled around 12 trillion yen to 13 trillion yen (US$76 billion to US$82 billion).
The Japanese government and the Bank of Japan conduct yen buying interventions by essentially undertaking sales of Japanese holdings of US dollar bonds. The more they sell, the higher the US Treasury bond yields rise (due to the lower bond price, higher yield effect) and these in turn put upward pressure on the whole range of US interest rates, since long-term mortgage rates are benchmarked on long-term Treasury bond rates. On July 30, the US 30-year rate hit 5.27% per year, last seen in 2004, while the 30-year mortgage rate hit 6.75%, last seen in 2006. This would affect residential property sales, and have an important impact on household confidence.
According to US Treasury data, in May 2026 the Japanese sold US$66.8 billion worth of their Treasury holdings, the largest monthly reduction since September 2022. So far, between February and May 2026, the net reduction of Japanese holdings of US Treasuries of between US$96 billion to US$100 billion is roughly equivalent to the estimated Japanese intervention to defend the yen against more depreciation. Since US government debt is now more than US$39 trillion, the higher the increase in bond yields, and consequently the US government interest bill, the larger the US fiscal deficit, as current US government interest expense in the budget for fiscal year 2026 has been estimated at US$1 tirillion to US$1.35 trillion, already exceeding the defence budget. With 10-year Treasury yield at around 4.7% per annum, this is already 55 basis points above the Congressional Budget Office’s early-2026 forecast of the fiscal deficit.
In short, we now have a double debt doom loop.
During the decades of Japanese deflation, when growth was flat or slow, the Japanese authorities, especially under former prime minister Shinzo Abe, used weak yen and lower interest rates to support the economy, incurring a very large Japanese government debt of 250% of gross domestic product (GDP), owing mostly to Japanese pension, insurance and long-term funds, not to foreigners. These funds bought US Treasuries to earn extra interest, when domestic yen rates were near zero. This encouraged the famous carry trade, where hedge funds could borrow yen and also invest in dollar or other assets to earn higher interest yields. The carry trade led to large inflows into the US, helping market liquidity and pushing US asset markets higher. It also enabled the US to keep interest rates low and enabled the US government to borrow at cheaper rates.
The carry trade was profitable when the gap between yen and dollar interest rates was wide. When the yen devalued, the hedge fund earned more profits because yen liabilities declined in dollar terms, while they also earned an interest rate spread. It seemed no risk with higher returns, based on a leveraged plan.
The carry trade stops when the interest rate differential between US dollar and yen assets narrows. This happened when Japanese domestic inflation began to rise, so the Bank of Japan began to raise interest rates, but was afraid to raise them too fast so as not to stall the domestic recovery, while at the same time, excessive sales of US dollar assets could also upset the US Treasury market.
The world’s two largest economies today face a quiet, common converging crisis — interest rates rising faster than the economies that must service their huge government debt.
For the US, with government debt at nearly 100% of debt-to-GDP and an average debt maturity of just six years, one third of the entire Treasury stock resets to new, higher yields every two years.
When the average interest rate on federal debt rises above the economy’s nominal growth rate of roughly 3.8%, debt begins compounding faster than the nation’s ability to pay it down. Today’s 10-year yields near 4.7% mean that the crossing point arrives around 2029-2031. Every sustained one-percentage-point rise adds roughly US$4 trillion to deficits over a decade.
Japan carries 250% debt-to-GDP, the highest in developed countries, but a longer debt maturity averaging 9.5 years, which delays the pain. However, if Japanese Government Bond yield grows above 3% per annum, debt service jumps by one-third.
The shared debt doom loop is a growing debt servicing trap that will end up with lenders wanting higher rates when the governments cannot afford to service the rising debt.
US Treasury Secretary Bessent is worried that if the yen depreciates further, other Asian currencies may further depreciate, pushing the dollar higher: “Many Asian currencies follow the Japanese yen, currently. [The] Korean won is weak because the yen is weak. Many people believe China has a very undervalued currency, and they are reluctant to strengthen the currency too much just because of yen weakness.”
That would also worsen US trade deficits, which would aggravate the global fiscal and trade imbalances. The topic of global imbalances is likely to be discussed extensively during this month’s meeting of central bankers at the annual Jackson Hole meeting hosted by the Kansas Fed.
So here’s the geonomic crisis looming. The more war expenditure and debt increase, the more the danger that lenders will not fund such deficits without higher interest rates. That would spark lower growth rates, and smaller deficit countries and stretched borrowers may default and trigger another cascading financial crisis. If the major reserve currencies of the world are going through the debt trap, what more for smaller, less well-managed developing countries? Investors beware.
Tan Sri Andrew Sheng writes on global issues from an Asian perspective
Save by subscribing to us for your print and/or digital copy.
P/S: The Edge is also available on Apple's App Store and Android's Google Play.