Japan Is Worrying the Bond Market. How Treasuries Can Avoid a Slump, for Now.

Secretary of the Treasury Scott Bessent. (Tom Williams / Getty Images)

President Donald Trump repeated his demand for the Federal Reserve to cut interest rates on Monday, claiming the U.S. should have the lowest in the world and save billions in government borrowing costs.

But action in some of the world’s biggest bond markets suggests investors aren’t as focused on central bank rates as he is. Instead, they are tracking debt levels, spending, and inflation, all of which are moving in the wrong direction for the president.

Tom Parker and Jeffery Rosenberg of BlackRock’s Systematic Fixed Income team describe a “new conundrum” for bond markets tied to inflation uncertainty, rising debt sales, and falling global demand.

“Longer-term interest rates can rise even as the Fed is expected to cut rates,” the pair wrote in a recent market outlook report. “And the direction of long-term rates may not follow Fed policy as strongly as it has in the past. Or even at all.”

U.S. debt is likely to surpass $40 trillion this year, according to the Congressional Budget Office. It forecasts an extra $3.3 trillion will be added to the nation’s overall tally over the next 10 years as a result of the tax-and-spending bill the president signed into law on July 4.

Inflation data set for release on Tuesday are likely to show accelerating price pressures as a result of tariffs. The latest projections from policymakers at the Fed call for their favored gauge, the core personal consumption expenditures price index, to rise to 3.1% by the end of the year from the 2.7% pace recorded in May.

So far, at least, the U.S. bond market hasn’t been as shaken by the debt and inflation concerns as it was when prices of fixed-income securities fell this spring. Yet recent moves higher in Japanese government-bond yields, which triggered a big U.S. market reaction in May, are starting to raise concerns.

The Bank of Japan has lifted rates twice this year, but signaled a dovish pivot last month when it focused on diminishing core inflation, a concern for the country, given its decadeslong battle with deflation. The European Central Bank, meanwhile, has cut its key deposit facility rate eight times over the past year, most recently in June.

Both of those moves would normally suggest lower, rather than higher, bond yields. But plans for billions in new military and infrastructure spending from Germany’s new government, and populist fiscal promises heading into next week’s Upper House elections in Japan, are having the opposite effect.

Longer-dated Japanese government bonds suffered their biggest selloff in two months Monday, taking the yield on benchmark 30-year paper to 3.159%. That is just a few ticks shy of the record closing high of 3.165% reached on May 23.

Data from Tradeweb also shows 30-year German government bonds, a proxy for longer-term risk in the euro zone, were last marked at 3.235%, the highest since 2011.

In the U.S., 30-year bond yields are trading just shy of the 5% market, but are some 10 basis points, or hundredths of a percentage point, north of last week’s levels.

While a surge in yields on Japanese debt sent Treasury prices sliding in May, this time appears to be different, at least for now. There are three reasons.

First, while renewed inflation risks are keeping short-dated bond yields elevated, improving fiscal figures tied to tariff revenue are supporting prices of longer-dated debt.

The Treasury reported an overall June surplus of $27 billion last week, compared with a $316 billion deficit in May. With calendar adjustments and tariff revenue, the overall budget deficit for the current fiscal year is now pegged at $1.34 trillion, around 1% lower than it was this time last year.

ING’s Padhraic Garvey, who heads the bank’s America’s research team, noted that while tax cuts tied to the government’s spending bill will hurt revenue collection next year, “the better news” is arriving first.

“One thing is true, the revenue benefits from tariffs and the cost cutting from the Department of Government Efficiency should act up front to calm the deficit data,” he said.

Second, broader market attention is likely to shift to the second-quarter earnings season, now beginning, keeping further increases in yields in check. Bond yields rise when prices fall.

Third, and perhaps more important, the Treasury’s quarterly refunding announcement arrives on July 30, the same day the Fed begins a two-day policy meeting in Washington. Secretary Scott Bessent is expected to continue his focus on borrowing heavily at the short end of the yield curve, even as he told Bloomberg Television last week that overnight rates are too high and the Fed is “a little off in their judgment” on growth and inflation.

Heavy issuance of short-dated debt could suggest he is more concerned about adding to the current schedule of longer-dated auctions than he is about whether the Fed ought to cut interest rates. All things being equal, more issuance of longer-dated debt would drive prices down and lift yields on 10-year Treasury debt, which help determine the cost of loans from car loans to mortgages and credit cards.

Write to Martin Baccardax at martin.baccardax@barrons.com