The US-Japan 10-year government bond yield spread recently dropped to 2.09%, the lowest since March 2022. Here are the data points: the US 10-year yield is stuck at 4.16%, while Japan's yield has surged to 2.07%, reaching a new high since 1997.

Interestingly, according to conventional logic, a narrowing spread should strengthen the yen, but the actual situation is the opposite— the US dollar against the yen has been rising. What’s behind this? The answer points to a troubling issue for the market: Japan’s debt crisis.

Japan’s government debt-to-GDP ratio has exceeded 230%. In an environment where yields are rising sharply, debt interest costs are soaring. The market is starting to question: can Japan’s finances still hold up? The key is that the Bank of Japan is very cautious about raising interest rates, so the rise in bond yields is interpreted by the market as a warning signal— Japan’s economy is in recession, not strong growth. This has actually increased the pressure to sell Japanese bonds.

On the other hand, the Federal Reserve has been slow to cut interest rates, with cuts smaller than expected, so the actual yield spread still favors the dollar. The appeal of carry trades has not diminished. Coupled with uncertainties from forex market interventions, multiple factors are working together to offset the positive effects of the narrowing spread. The result is that the yen’s movement does not match textbook expectations.

Where should future focus be? When will the Fed actually implement rate cuts and by how much; will the Bank of Japan raise rates more quickly; can Japanese government bond auctions proceed smoothly, and how should we interpret debt data? These three variables will determine whether the exchange rate pattern can break the current deadlock.