Rock and a Hard Place

21 November 2025

There has been a correction in risk assets over the past few weeks. While it has been orderly at the index level there has been a deeper correction in some of the popular exposures (data centre names) and in some of the listed private asset companies providing the finance. Investors were, quite rightly, focussed on NVDIA which reported after the market close on Wednesday in the United States. The bullish case, as we noted last week, is that we are only halfway through the AI capital spending super cycle and productivity boom. From a broader macro perspective, financial conditions remain supportive, and the fiscal impulse is likely to support growth next year as well. Put another way, the US Administration is motivated to “run the economy hot” into the mid-term elections next year.

The positive fiscal impulse is a cyclical support for growth in the United States and developed markets more broadly. In the medium term, the current level of debt and the pace of growth is not sustainable. Debt levels are already high; demographics will add to spending (there will be fewer taxpayers) and high real interest rates are deteriorating debt servicing. America’s cycle-adjusted deficit is already -7.7% of GDP. It is already at great depression levels before any potential rise in unemployment.

A few astute clients have also noted the sharp rise in Japanese government bond yields since the new administration announced another fiscal support package last week. Indeed, the long end of the Japanese yield curve has increased to 3.37% (at the time of writing) from a low of 0.10% in September 2019 just before COVID (chart 1). Recall that in the period between 2016 and 2019, low trend growth, low inflation and low rates were believed to be a “permanent state.” Some observers argue that Japan has demonstrated that debt levels can go a lot higher without causing a crisis. However, the key reason Japan has been able to sustain high debt is that most of the debt is held by domestic institutions including the Bank of Japan. Moreover, Japan has been a net saving country (in aggregate) so it has largely self-financed its public deficit. By contrast, the United States is a large net borrower.

Chart 1

Source: Bloomberg

Japan’s large net foreign assets are also part of the global vulnerability. If the Bank of Japan chooses to re-introduce yield curve control (increase purchases of long end JGBs) the release valve would likely be via the currency (Japanese yen depreciation). However, if rapid disorderly yen depreciation contributed to reflexive or self-reinforcing inflation in Japan that might force Japanese institutions to repatriate foreign assets (foreign bonds and equities) to stabilise the yen. The impact would likely be a rapid and episodic unwind of carry positions in all forms. The Bank of Japan can choose to save the bond market or the currency, but probably not both.

On the positive side, our understanding is that speculative positions in yen funded carry trades are not as extreme as they were in July 2024. Nonetheless, implied USDJPY yen volatility is still very low in a historical context and the rise in long end JGB yields has been rapid and non-trivial over the past few weeks and especially since the low in 2019 (chart 2). Low implied volatility suggests liquidity and leverage (fragility risk) is elevated. As we often note, the real world is not linear and systemic risk can increase at an accelerating rate as correlation moves to one in a major episode.

Chart 2

Source: Bloomberg

20251121_Rock_And_Hard_Place.pdf

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