Core Insights - An inverted yield curve has historically signaled impending recessions, but the recent inversion in 2023 did not lead to a recession, marking a rare false signal in 50 years [3] - A steeper yield curve typically indicates positive economic growth expectations and lower inflation risk, but recent developments in Japan suggest that rising long-term yields may be driven by inflation concerns rather than economic improvement [4][5] Yield Curve Basics - The yield curve measures bond yields across various terms, usually exhibiting a positive slope where longer-term yields are higher than short-term yields, reflecting a term premium for locking money away longer [2] - An inverted yield curve occurs when short-term yields exceed long-term yields, often influenced by central bank policies and economic expectations [2] Recent Trends - The U.S. yield curve has transitioned from inversion in 2023 to a flat and then positively sloped curve expected in 2025, indicating falling inflation risk and improving economic growth prospects [4] - Japan's yield curve has steepened due to rising long-term yields, which are not justified by economic fundamentals but rather by inflation and debt sustainability concerns, with Japan's gross debt at approximately 230% of GDP [4][5] Investment Implications - Rising yields in Japan may increase borrowing costs for carry trades, potentially leading to unwinding positions that could negatively impact global asset prices [5] - If global long-term yields rise due to inflation fears rather than economic growth, bonds may not serve as effective portfolio stabilizers, leading to elevated correlations between equities and bonds [6] Future Considerations - Attention to inflation and debt sustainability risks is expected to increase, which may reduce the defensive role of bonds in portfolios, necessitating alternative strategies such as holding cash or commodities [7] - The need for diversified defense strategies in investment portfolios has become more critical in recent times, as traditional bond investments may not provide the expected stability [7]

M Idea Morgan Stanley Asia Limited Chetan Ahya Chief Asia Economist Chetan.Ahya@morganstanley.com +852 2239-7812 Morgan Stanley Asia (Singapore) Pte. Derrick Y Kam Asia Economist Derrick.Kam@morganstanley.com +65 6834-8272 Morgan Stanley Asia Limited Jonathan Cheung Economist Jonathan.Cheung@morganstanley.com +852 2848-5652 Kelly Wang January 27, 2026 06:57 PM GMT Asia Economics | Asia Pacific The Viewpoint: Investors' Concerns About Japan's Fiscal Position Are Overdone In this slide deck, we highlight the ...

Economic Theory vs Research Findings - Economists traditionally believe productivity and interest rates move in the same direction [1] - Some research suggests interest rates increase more than growth, potentially worsening debt sustainability [1]

Summary of Key Points from the Conference Call Industry Overview - The analysis focuses on the **advanced economy debt** landscape, highlighting deteriorating debt levels, interest costs, and fiscal deficits across various countries, particularly the **US** and **France** [2][10]. Core Insights and Arguments - The **debt sustainability analysis (DSA)** framework was updated, indicating that the relationship between the cost of debt (R) and nominal growth (G) is critical for assessing debt sustainability. When R exceeds G, risks increase significantly [3][10]. - The **debt-to-GDP ratio** for developed markets (DM) is projected to reach approximately **130% by 2030**, which is **3 percentage points higher** than previous projections made 18 months ago [4][10]. - The **cost of debt** has risen by approximately **23 basis points**, and nearly half of the countries analyzed need to achieve a primary fiscal surplus to prevent rising debt levels [10][12]. - The **US** is projected to exceed a **140% debt-to-GDP ratio by 2030** unless it can achieve a primary surplus, which is currently forecasted at a **-3.8% of GDP** deficit for 2026 [11][13]. - The **French government** is also facing significant fiscal challenges, with the need for a primary balance or surplus to stabilize its debt levels [12][13]. Additional Important Insights - The **US government shutdown** has created market volatility, primarily due to delays in data releases rather than immediate fiscal implications. The potential for larger government spending cuts is being discussed in light of increasing deficits [2][10]. - Historical patterns suggest that when nominal growth softens and debt tenors shorten, markets may react negatively, indicating a potential risk for future debt sustainability [15]. - The **political landscape** in countries like the US and France complicates efforts to achieve fiscal balance, with significant challenges in moving from deficits to surpluses [12][13]. Conclusion - The current fiscal outlook for advanced economies is concerning, with rising debt levels and the need for substantial fiscal reforms to ensure sustainability. The interplay between growth, debt costs, and political will will be crucial in determining future outcomes [10][11][12].