After the USA announced a pause on tariffs last week, Japan became the first country to engage in substantive negotiations this week.

On Monday, Nomura Securities released a Research Report stating that the USA chose Japan as the first target for trade negotiations, intending to make it a 'model case' for reaching agreements with other countries.

Although the Japanese government has promised to increase investments in the USA and procure Energy, the USA may not be satisfied with this and intends to push for a package of conditions that may be difficult for Japan to accept easily.

For instance, requiring Japan to set clear trade surplus targets, forcing Japan to 'buy more and sell less', interfering with Japan's trade balance; promoting the appreciation of the yen, which could harm export companies and stifle Japan's economic recovery; requesting Japan to extend the duration of its holdings in US Bonds, limiting the flexibility of Japan's Forex reserves; increasing government fiscal spending, which would further exacerbate the supply pressure in Japan's bond market, pushing up Japan's long-term bond yields.

Each of these conditions is challenging for Japan, and if the aforementioned demands materialize, they will create multiple constraints for Japan.

According to the Japan Associated Press, Japanese Prime Minister Shigeru Ishiba emphasized in parliament on Monday that Japan will not compromise to reach an agreement quickly and highlighted the importance of cooperation with long-term allies:

"Rushing to complete negotiations could lead to failure, and making excessive concessions just to reach an agreement is not a wise move."

If the USA's requests come true, the yen should rise, and the bond market should explode?

The report clearly indicates that the potential demands from the USA could have a significant impact on Japan's financial market.

Nomura warns that if the USA successfully applies pressure, the dollar may weaken rapidly, and the yen will appreciate significantly. Additionally, against the backdrop of high risk aversion, the yen is likely to be viewed as a substitute for the dollar, and the continuous inflow of funds will intensify appreciation pressure.

An appreciation of the yen means a decline in the competitiveness of Japanese commodity exports, directly hitting manufacturing enterprises that are export-oriented. This 'strong medicine-style appreciation' may far exceed Japan's economic capacity.

In terms of the bond market, the USA may demand that Japan increase fiscal expenditure to stimulate domestic demand and expand purchases from the USA. However, the issue is that more expenditure requires more funding, meaning that the Japanese government will issue more government bonds to raise this capital, which will significantly increase the supply of government bonds.

Nomura points out that Japan's government bond market, particularly the ultra-long-term segment, has already shown signs of unstable supply and demand. If the USA demands that Japan expand fiscal expenditure, it will cause an already tight ultra-long-term government bond market to become even more imbalanced, leading to a rapid surge in long-term interest rates and a steepening of the yield curve. Meanwhile, expectations for a rate hike from the Bank of Japan this year have been lowered (Nomura predicts the first rate hike will be delayed until January 2026), intensifying the volatility risk in the bond market.

On Monday, the yield of Japan's ultra-long-term government bonds rose sharply during the session, with the 20-year government bond yield soaring 7 basis points to 2.435%, marking a new high since 2004, while the 30-year yield skyrocketed by 12 basis points to 2.845%. This severe fluctuation occurred before Tuesday's auction of the 20-year government bonds, but more importantly, the market is digesting the expectation that the Japanese government will soon launch a massive supplementary budget plan.

Additionally, Nomura warned of imbalances in the global bond market, where the risk of liquidity tightening may worsen.

Nomura stated that last week the global stock market rebounded initially due to news of a delay in Trump's tariffs, but then weakened again. The spread on High Yield Bonds, a 'canary indicator' of credit tightening, continues to widen, and the most severe issue is that the supply and demand for global bonds has significantly collapsed, with USA ultra-long-term government bonds becoming a source of turbulence, no longer providing a safe haven for risk-averse markets.

In this context, if government bonds and MMF functions fail, investors may be forced to fully cut positions, further exacerbating risk-averse sentiment. If the Federal Reserve maintains its hawkish stance, refusing to lower interest rates, and market liquidity remains tight, it will intensify credit contraction and may even trigger a liquidity crisis.

Editor/lambor