The Shock of US Debt Reaching $40 Trillion: Will the Rise in Long-term Interest Rates Hit Japan?

In the U.S. financial markets, a slightly different kind of issue is emerging.

What will happen with inflation?

When will the Federal Reserve (FRB) cut interest rates?

Are employment statistics strong or weak?

Until now, these factors related to monetary policy and the economy have been central when considering U.S. Treasury yields.

However, a new significant variable has been added.

It is the fiscal condition of the U.S. government itself.

In August 2026, U.S. government debt finally surpassed the $40 trillion mark. Reuters reports, based on U.S. Treasury figures, that of the government debt exceeding $40 trillion, the portion held by markets and others has also expanded to over $32 trillion.

An article published by Seeking Alpha on August 22 posed a very important question to investors.

"Will the ever-increasing government debt push up U.S. Treasury yields?"

That is the question.

At first glance, the answer seems simple.

As debt increases, the issuance of government bonds also increases.

To absorb a large amount of government bonds in the market, it is necessary to offer investors higher yields.

Therefore, if government debt increases, interest rates will also rise.

However, the actual financial market is not that simple.

This issue seems to be an important theme for considering future global markets and Japan's financial market.

The dangerous cycle of "the more debt increases, the higher interest rates rise"

In the Seeking Alpha article, Jack Bowman presented a relatively straightforward pessimistic scenario.

Unless the U.S. Congress shifts to a fiscal structure that consistently generates fiscal surpluses, the increase in debt will be a factor pushing up Treasury yields.

The government continues to run fiscal deficits.

To cover that deficit, new government bonds are issued.

As the supply of government bonds increases, investors demand higher interest rates instead of purchasing them.

If interest rates rise, the government's interest payment expenses increase.

As interest payment expenses increase, the fiscal deficit further expands.

And once again, the issuance of government bonds increases.

In other words,

Debt increase
→ Increase in government bond issuance
→ Rise in long-term interest rates
→ Increase in interest payment expenses
→ Expansion of fiscal deficit
→ Further increase in debt

There is a possibility that a self-reinforcing loop like this could emerge.

Bowman points out that this "vicious cycle" could start spinning faster due to sustained fiscal deficits.

The problem is that this discussion is no longer just theoretical.

The future of "2036" as shown by the CBO

Looking at the fiscal outlook published by the Congressional Budget Office (CBO) in February 2026, it is clear that the U.S. fiscal problem will not end in the short term.

According to the CBO's forecast, federal government debt held by the market will be 101% of GDP in 2026.

This is expected to rise to 120% by 2036.

It is projected to surpass the 106% recorded right after World War II in 1946, reaching the highest level in U.S. history.

What is even more noteworthy is the interest payment expenses.

According to the CBO, the U.S. government's net interest payment expenses are expected to increase from about $1 trillion in 2026 to about $2.1 trillion by 2036.

As a percentage of GDP, this will rise from 3.3% to 4.6%.

By 2036, the interest payment expenses alone will be almost equivalent to the entire discretionary spending of the U.S. federal government.

This is extremely important.

Social security costs, public investment, and defense spending can theoretically be reduced by political decisions.

However, interest payments on government bonds are different.

The interest on issued government bonds cannot be said,

"We won't pay this year because the fiscal situation is tough."

You can't say that.

If refinancing continues at high interest rates, the government's spending structure will automatically deteriorate.

The CBO itself also analyzes that interest payment expenses will increase significantly due to rising long-term interest rates and increasing debt balances.

Still, it's not definitive that "more debt leads to higher interest rates"

On the other hand, Marc Chandler from Seeking Alpha shows a cautious stance on this discussion.

He believes it is difficult to derive government bond yields solely from the size of government debt.

Japan is cited as a representative example.

Japan has held an outstanding amount of government debt among developed countries.

Nevertheless, government bond yields remained extremely low for a long period.

In China, too, there are situations where high levels of government-related debt coexist with low interest rates.

In other words,

"High government debt does not necessarily mean high long-term interest rates."

Such a simple relationship does not exist.

Chandler also suggests that, for the U.S., there is no clear evidence at present that the market is genuinely fearful of U.S. fiscal conditions.

This is an important counterargument.

Factors influencing government bond yields include not only government debt but also,

inflation rates,

economic growth rates,

central bank monetary policies,

demand for safe assets,

global savings,

demand for the dollar,

regulations on financial institutions,

investment demands of pension and insurance companies,

foreign currency reserves of overseas central banks,

geopolitical risks,

among many other factors.

If a severe economic downturn or financial crisis occurs, even if U.S. government debt increases, investors worldwide might buy U.S. Treasuries as "safe assets," potentially lowering yields.

Therefore, the issue is not a simple "debt increase leads to interest rate rise."

More accurately,

whether the increase in debt begins to raise the fiscal risk premium demanded by investors

is what's important.

The truly important thing is not "$40 trillion"

The figure of $40 trillion in U.S. debt has a strong impact.

However, what is truly important for investors is not the total amount of debt itself.

What matters is,

"At what interest rate will the market buy the U.S. Treasuries to be issued in the future?"

This is the point.

Even if the U.S. government issues a large amount of government bonds, if there is strong demand from around the world, interest rates may not rise significantly.

Conversely, if investors start to think,

"I don't want to buy at 4%,"

"I'll buy at 5%,"

"No, I need 6%,"

then the U.S. government's funding costs will rise rapidly.

Thus, the essence of the U.S. fiscal problem is,

not the absolute amount of debt, but how much interest the market demands on that debt

that matters.

"Bond Vigilantes" gaining attention on social media

Recently, the term "Bond Vigilantes" has been gaining attention again in overseas investor communities.

 

In Japanese, it is translated as "債券自警団" (bond vigilantes).

Of course, there is no actual investor organization by that name.

It refers to the phenomenon where bond investors sell government bonds and push up long-term interest rates to demand fiscal discipline from the government if it continues excessive fiscal expansion or inflationary policies.

In the Reddit Value Investing community, there is a discussion about whether the bond market is starting to demand corrections in fiscal and monetary policies from the government and the FRB amid rising U.S. long-term interest rates.

"Is the bond market starting to demand fiscal and monetary policy corrections from the government and the FRB?"

Such discussions can be seen.

There are also posts that consider the possibility of Japanese investors or pensions selling U.S. Treasuries as a market risk.

Interestingly,

"If Treasury yields exceed 5%, is there really a need to buy stocks?"

is a topic of discussion.

Stocks inherently carry the risk of price declines.

On the other hand, if U.S. Treasury yields approach 5%, it becomes possible to earn high yields while relatively suppressing credit risk.

Therefore,

"Should one accept significant price fluctuations to aim for an expected return of around 8% in stocks?"

Or,

"Should one secure around 5% with U.S. Treasuries?"

This choice becomes realistic.

This has significant implications for stock market valuations.

On the other hand, there are voices saying "Now is the time to buy long-term bonds"

However, social media and investor comments are not solely filled with pessimism.

In the comments section of Seeking Alpha, there are comments viewing the current price level of TLT, a long-term U.S. Treasury ETF, as an investment opportunity.

This well reflects the characteristics of bond investment.

When interest rates rise, the prices of long-term bonds already held fall.

However, from the perspective of new investors, it becomes possible to invest at higher yields.

And in the future, if interest rates fall due to an economic downturn, the prices of long-term bonds may rise.

Therefore,

the view that "long-term bonds are dangerous because U.S. long-term interest rates are rising"

and the view that "long-term bonds have become attractive precisely because interest rates have risen sufficiently"

coexist.

It is only natural that social media reactions are widely divided.

Japan is the world's largest "foreign holder of U.S. Treasuries"

According to the U.S. Treasury's TIC statistics, as of the end of June 2026, Japan holds about $1.1167 trillion in U.S. Treasuries.

Surpassing the UK at about $940 billion and mainland China at about $633.4 billion, Japan remains the largest foreign holder of U.S. Treasuries.

In other words, Japan is not just a spectator.

It is one of the massive capital providers supporting the U.S. Treasury market.

Japanese life insurance companies, banks, pensions, and asset management companies have long used U.S. Treasuries as important investment assets.

Therefore, the rise in U.S. Treasury yields and the fall in prices also affect the investment performance of Japanese financial institutions.

The possibility that rising Japanese interest rates could change the U.S. Treasury market##