The U.S.–Japan trade deal landed with fanfare this week, cutting tariffs from 25% to 15% and sending Japanese equities soaring—Toyota posted its best day since 1987, and the Topix neared all-time highs. But beyond the market reaction, the agreement laid bare the deep structural fragility of Japan’s economy. Facing mounting U.S. pressure and reeling from a crushing election loss, Prime Minister Ishiba signed off on sweeping concessions—including tariff relief on autos and agriculture and a highly publicized $550 billion investment pledge. That pledge, notably, comes with a twist: President Trump has broad discretion over how the funds are allocated, a detail that has sparked concern in Tokyo.
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Japan’s willingness to concede so quickly reflects just how strained the foundation has become. GDP growth remains anemic at just 0.6% year-over-year, and public debt has ballooned past 230% of GDP. Demographics continue to deteriorate: the population shrank again in 2024, the fertility rate has dropped to 1.14 children per woman, and the government is now offering monthly subsidies and even housing incentives to get families to relocate and reproduce. Meanwhile, Japan’s global financial clout may be weakening. The tariff deal is expected to reduce the country’s trade surplus, which means less money to invest abroad—posing a longer-term headwind for global bond and currency markets.
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One casualty could be the yen itself. Long prized for the “yen carry trade”—a strategy where investors borrowed cheaply in yen to invest in higher-yielding assets abroad—the currency is now losing appeal. As rates rise and political risk grows, that reliable stream of global demand for the yen is starting to dry up. At the same time, Japanese bond markets are flashing red: 30-year yields surged to record highs this week, raising fears that the decades-long period of ultra-cheap government borrowing is coming to an end. While the Bank of Japan is now signaling earlier rate hikes, fiscal pressure and political instability are complicating its next move. For now, Japan has secured short-term relief—but at the cost of revealing just how fragile its economic position has become.