The world is on a grim and unpredictable path, with geopolitical upheaval, military conflicts, and economic derailments creating an explosive combination with unpredictable consequences.
The Middle East looks like a powder keg ready to explode, as Israel and Iran are one step away from open conflict.
Meanwhile, the United States is sinking deeper into a swamp of unmanageable debt, while Japan struggles to contain a monetary and fiscal crisis that threatens to engulf the global system.
Trust Economics is sounding the alarm, warning that a new global cycle of terror has already begun — and no one can predict where it will end.
Middle East
Iran’s Supreme Leader Ayatollah Khamenei said talks with the United States on his country’s nuclear program are unlikely to “lead to any results”… as US intelligence reports suggest Israel is preparing to attack Iran, sending oil prices soaring.
The Israeli press also notes that Iranian efforts to recruit Israeli agents are increasing, while Tehran is trying to stage high-profile assassinations inside Israel in an attempt to “retaliate” for Israeli operations inside Iran, further escalating tensions.
This comes as former President Trump reportedly appears frustrated with the war in Gaza and wants Prime Minister Netanyahu to “end” it.
Meanwhile, the E.U. will review the association agreement with Israel, as European officials admit that only diplomacy has prevented the agreement from being suspended so far; while the United Kingdom has suspended trade talks with Jerusalem and spoken out against its “heinous extremism.”
In addition, US Secretary of State Marco Rubio, referring to Syria, said: “Our assessment is that, frankly, the transitional authority, given the challenges it faces, may be only a few weeks — not many months — away from a possible collapse and a full-scale civil war of epic proportions, which would essentially lead to the disintegration of the country.”
This assessment is the basis for the lifting of US and EU sanctions against Syria. In short, the entire region, rich in energy resources, is in turmoil. And not only this one.
US Economy
According to Trust Economics, the International Monetary Fund has urged the US to reduce its budget deficit as Trump’s “Big, Beautiful Bill” includes tax cuts and significant spending increases.
At the same time, the US is “preparing for a long war with China that could even hit US bases and US soil itself,” and Trump is preparing to unveil a new $175 billion missile defense system called “Golden Dome” — which will almost certainly not be ready during his term, despite his assurances.
Trump is also reportedly calling on the UK to increase its defence spending to 3% of GDP by 2029, within the current parliamentary term, which would further increase the country’s budget deficit.
In this context, Moody’s downgrading of the US credit rating last Friday came as no great surprise—US debt was already trading “as if it were no longer AAA.” However, the downgrade has potential repercussions in various corners of the market.
The managers of Hong Kong’s mandatory pension fund (MPF) are warning that they may be forced to sell their US government bonds, as the fund only allows more than 10% of its assets to be invested in US securities if the country maintains a AAA rating or equivalent from an approved rating agency.
The only approved agency that still maintains the highest rating for the US is Japan’s Rating & Investment Information, which continues to consider the US rating stable and states that “the situation has not changed significantly” since its previous assessment in February.
But of course, other scenarios could also arise.
The US Congress is close to approving Trump’s tax cuts, which will lead to a significant increase in deficits and debt: with the IMF publicly asking the US to reduce its deficit, such a scenario could lead to a gradual reduction in the share of US government bonds (Treasuries) in various investment portfolios.
A Trump executive order under consideration to allow U.S. pension funds access to private equity investments could potentially have the same effect, giving savers the ability to provide funds focused on “corporate acquisitions and other high-risk deals” — so, fewer Treasuries.
Japanese auctions
Meanwhile, while long-term European and German bond yields are trading 30-40 basis points lower than in early March, yields in the US and Japan are close to or even higher than those levels.
A recent auction of 20-year bonds in Japan saw the lowest demand since 2012, pushing the yield on the 30-year Japanese bond to its highest level since its issuance in 1999.
It doesn’t help, of course, that the Japanese prime minister himself admits that the country’s fiscal situation is “extremely bad, worse than Greece’s” — even if that statement is intended to reject new tax cuts that would be financed with additional borrowing.
Core inflation in Japan has fallen from highs of close to 3% per year at the end of 2023 to just above 1.5%. However, this level has only been exceeded twice in the past three decades: in 1997 and 2014 — in both cases, the inflation spike was caused by changes to the VAT.
If Japan has now entered a period of more “normal” inflation, then this could put more persistent upward pressure on (real) bond yields, raising borrowing costs.
As in the US and Europe, the Japanese central bank has reduced its bond purchases, which, combined with weaker demand, may contribute to rising liquidity premiums.
Japan’s debt-to-GDP ratio (214% in 2024) is the highest among advanced economies. The Bank of Japan still holds about 50% of government debt, but even if it continues to buy, the “net” debt level will remain above 100% of GDP — similar to Greece in 2007. We don’t want to “burn” the Japanese bond market — after all, betting against it is known as “widow’s trading.”
But we wonder whether Japan can serve as an example for Europe or even the US — Japan, after all, has been the testing ground for many unconventional monetary policies in recent history. First, the country may be better placed than its peers to handle bond market turmoil and the impact of higher yields on the government’s financing costs.
Just 12% of Japanese government bonds (JGBs) are held by foreign investors. The government could therefore impose some kind of wealth tax to recoup some of the interest payments on its bonds.
There are similarities here to the proposal for a “Mar-a-Lago deal,” in which the United States could try to reduce its debt-servicing costs by either forcing its allies to extend the duration of their holdings of bonds with below-cost yields or by imposing a tax on foreign holders of Treasuries.
The key difference is that Japan’s solutions could be less controversial, since domestic tax policies would suffice.
However, such a tax recovery has limited effectiveness. A wealth tax that offsets higher debt service costs helps contain the budget deficit and debt, but it does not provide additional fiscal space for strategic goals — such as defense spending or reducing dependence on imports (similar problems exist in Europe).
Without monetary support, larger tax increases or spending cuts would be required — which could erode support for the ruling party. Alternatively, the Bank of Japan could restart government bond purchases.
But that would likely lead to higher inflation and a weaker currency — at a time when the yen is already under increased scrutiny by the US government.
Japanese Finance Minister Kato said that “exchange rates should be determined by markets and that excessive volatility has economic and financial implications.”
The yen’s weakness could undermine any trade deal between the US and Japan. So to mitigate the impact of quantitative easing, could the Bank of Japan raise interest rates at the same time, attempting to achieve a neutral policy mix: higher interest rates with yield curve control?
China
Meanwhile, on trade: China’s Xi steps up calls for industrial self-sufficiency — so no reorientation, then? — and China says it will respond to U.S. restrictions on semiconductors.
Malaysia moves ahead with Huawei’s AI, testing U.S. stance on the issue, while Nvidia CEO says U.S. restrictions on China are “failing.”
G7 nations discuss tariffs on cheap Chinese goods flooding markets. EU considers 2-euro fee on incoming packages from China. It is also expected to propose quotas for Russian natural gas, giving companies legal means to end their contracts.
U.S. says new sanctions on Russia could hurt peace talks.
India has imposed restrictions on nearly 42% of imports from Bangladesh.
And Japan is taking a tough stance in trade talks, demanding that the US remove all reciprocal and sectoral tariffs.
So, indeed, much is in a state of flux.
