Japan's rapidly weakening yen is no longer simply a domestic economic issue. According to geopolitical and economic analyst Lena Petrova, mounting pressure on Japan's currency could eventually spill into US Treasury markets, raising borrowing costs worldwide and exposing vulnerabilities throughout the global financial system.
INR Report: Based on commentary by Lena Petrova for World Affairs In Context.
The yen's dramatic decline
For decades, the Japanese yen was regarded as one of the world's safest currencies. During previous financial crises, investors often fled to the yen as a safe-haven asset.
Today, that reputation is being tested.
The yen has fallen to around 163 yen to the US dollar, its weakest level in almost forty years. While this initially appears to be a Japanese problem, Petrova argues the consequences extend far beyond Japan's borders.
Japan remains the largest foreign holder of US Treasury securities, meaning any attempt to defend its currency could have significant consequences for America's government bond market.
The carry trade explained
Petrova says one of the biggest drivers behind the yen's decline has been the large gap between US and Japanese interest rates.
For years, investors have been able to borrow money cheaply in Japan, convert those funds into US dollars and invest in higher-yielding American assets such as US Treasury bonds.
This strategy—known as the yen carry trade—has become one of the largest sources of liquidity in global financial markets.
As long as US interest rates remain substantially higher than Japan's, investors continue selling yen to buy dollars, placing ongoing downward pressure on the Japanese currency.
Why America should care
According to Petrova, defending the yen requires Japan to purchase its own currency by selling foreign assets—primarily US dollars.
To obtain those dollars, Japan may need to sell part of its enormous holdings of US Treasury securities.
Under normal conditions, financial markets could absorb modest sales. However, Petrova notes reports suggesting Japan's holdings of foreign securities declined by around US$75 billion during May 2026, potentially signalling that reserve drawdowns have already begun.
If larger Treasury sales become necessary, yields on US government debt could rise further, increasing borrowing costs across the American economy—from mortgages and business lending to federal debt servicing.
A difficult balancing act
Japan faces few easy options.
Government debt now exceeds 250 percent of GDP, giving Japan one of the highest debt burdens among developed economies.
Raising Japanese interest rates could strengthen the yen but would also sharply increase the government's own financing costs.
Leaving rates low, however, risks allowing the currency to weaken further.
Petrova argues policymakers are effectively caught between "a rock and a hard place," with neither option offering an attractive long-term solution.
Global consequences
Petrova concludes that today's financial system has become so interconnected that major currency movements in Tokyo can quickly affect bond markets in New York, equity markets in London and commodity markets around the world.
She argues investors should increasingly focus on sovereign debt markets rather than equities, suggesting the greatest financial risks may now lie within government borrowing rather than stock prices.
If Japan ultimately continues selling US Treasuries to defend its currency, she believes the consequences will extend well beyond Asia, influencing borrowing costs, capital flows and financial stability across the global economy.
Does This Affect New Zealand?
Although the immediate pressure is centred on Japan and the United States, New Zealand is unlikely to remain insulated if stress develops in global sovereign debt markets. The New Zealand dollar is a fiat currency operating within an international financial system where the US dollar remains the dominant reserve and settlement currency. Significant disruption in US Treasury markets would likely flow through to global interest rates, investor confidence and the cost of international capital.
For New Zealand, that could mean higher borrowing costs for government, businesses and households, even without any domestic economic shock. A sustained rise in US bond yields has historically influenced funding costs across international banking markets, including those relied upon by New Zealand's banking sector.
The situation also raises a broader strategic question. As global debt markets become increasingly volatile, New Zealand may need to examine how exposed it is to international monetary conditions beyond its control. Strengthening economic resilience through greater domestic capital formation, prudent fiscal management, diversified trade relationships and the development of strategic reserve assets could reduce vulnerability should instability emerge in the international fiat monetary system.
Source
Original Commentary: Lena Petrova, World Affairs In Context.