Japan stays cautious while US credit downgrades

For decades, U.S. Treasuries were the undisputed refuge during times of market stress - predictable, liquid, and backed by the full faith of the federal government. But the world’s most trusted financial backstop is starting to look a bit shaky.

Moody’s just downgraded the U.S. credit rating, capping a years-long slide from fiscal discipline to mounting deficits and policy gridlock. The move didn’t shock the markets - but it did confirm what many had feared: America’s debt problem is no longer a future concern. 

Meanwhile, across the Pacific, Japan is navigating its own storm. Sluggish growth, structural debt, and new U.S. tariffs. But unlike Washington, Tokyo is showing signs of restraint. With rate hikes still on the table and political leaders pushing back against pre-election spending sprees, Japan isn’t thriving,  but it is watching its step. 

When the world’s largest economy gets a red flag, could we be in for a global crisis?

Moody's rating downgrade: America’s perfect credit is gone 

On 16 May, late Friday evening and after markets had shut for the week, Moody’s quietly dropped a bombshell: it downgraded the United States’ sovereign credit rating from Aaa to Aa1. The announcement capped a slow-burning trend, all three major ratings agencies have now cut America’s once-pristine status.

Their reasons are hard to dismiss. The U.S. national debt has crossed $36 trillion, and there’s no credible plan to rein it in. President Donald Trump’s new tax cut package, approved by a key committee after days of Republican infighting, could add up to $5.2 trillion to the deficit by 2034, according to some estimates. 

Yet Washington shows little interest in matching giveaways with spending restraint. Moody’s warned that “successive administrations have failed to reverse the trend of rising fiscal deficits and debt.” The agency doesn’t expect material improvement from any proposal currently on the table. In other words, the U.S. isn’t just in debt - it’s in denial.

US Treasury yields and bond market outlook

The market response was swift. U.S. 30-year Treasury yields briefly shot above 5%, while 10-year yields climbed by double digits. 

Rising yields are more than a footnote - they’re a signal that investors are demanding greater compensation for holding U.S. debt, which is no longer seen as bulletproof.

“We’re entering an era where fiscal recklessness actually costs something,” said one strategist. The return of so-called bond vigilantes - investors who punish governments for unsustainable policies - is no longer a theoretical threat. It’s happening.

The dollar, too, has begun to feel the pressure. While it hasn’t collapsed, it’s wobbling. The USD/JPY pair dropped below the key 145.00 mark, reflecting a stronger yen and a softer greenback. That shift is partly driven by diverging central bank paths - the U.S. Federal Reserve is expected to cut rates later this year, while the Bank of Japan may tighten further.

But it’s also about trust. When the world’s “risk-free” asset gets downgraded, people start asking uncomfortable questions.

Japan’s cautious posture draws quiet attention

Japan, for its part, remains under considerable strain. The economy contracted by 0.7% (annualised) in the first quarter of 2025 - its first decline in a year. 

Structural issues persist, from demographic headwinds to a debt-to-GDP ratio that remains among the highest in the developed world. And fresh U.S. tariffs are adding another layer of uncertainty.

Even so, Japan’s policy stance has been comparatively measured. After years of ultra-loose monetary policy, the Bank of Japan is now signalling that further tightening remains on the table. Deputy Governor Shinichi Uchida noted this week that inflation could pick up again, and the central bank would respond accordingly.

On the fiscal side, Prime Minister Shigeru Ishiba has taken a firm stance. He recently resisted calls to lower the consumption tax ahead of a key election, warning that Japan’s fiscal position remains fragile. His message wasn’t flashy - but it landed clearly with markets: short-term popularity won’t be bought at the expense of long-term stability.

This doesn’t imply strength, nor does it suggest that Japan is suddenly a model. But in a financial environment where discipline is once again being priced in, such signals carry weight.

Repricing risk in a changing landscape

Traditionally, when uncertainty rises, money flows into U.S. assets almost by default. But that reflex is weakening. Investors are now more willing to reassess assumptions that once went unquestioned.

The downgrade of U.S. debt hasn’t triggered a crisis - but it has removed a layer of comfort. With the Federal Reserve nearing the end of its tightening cycle, and fiscal outlooks worsening, the ground beneath “risk-free” assets feels less firm.

There’s also a practical consideration: if Japan continues to manage its own bond market through tightening, it may begin trimming its foreign holdings - including U.S. Treasuries, where it remains the second-largest holder. That could push U.S. yields higher still, adding to funding pressures already building in Washington.

Technical outlook: USD/JPY forecast

To be clear, no one’s saying the dollar will be dethroned overnight, or that Japan is poised to take over as the financial capital of the world. But perception matters. And right now, the perception that America always does the right thing in the end is starting to erode.

The irony is thick: Japan, long mocked for its stagnation, is becoming a symbol of discipline. America, once the poster child for fiscal strength, is now flirting with unsustainable debt, partisan paralysis, and credit downgrades.

The world is watching - and, increasingly, it’s hedging.

At the time of writing, the USD/JPY pair is slumping towards the $144.00 mark. Sell-side bias is evident on the daily chart. However, the volume bars paint a picture of waning sell pressure, which could mean an uptick in prices. Should the pair continue to slump, prices could find a support floor at the $142.10 price level. If we see an uptick, prices could encounter resistance walls at the $145.51 and $148.29 price levels. 

Will the USDJPY pair continue to slide? You can speculate on the price trajectory of USDJPY with a Deriv MT5 or Deriv X account.