By Jörg Held, Head of Portfolio Management at ETHENEA Independent Investors S.A.
Something is brewing in Japan. As the country elects a new parliament on February 8, 2026, the financial world is watching Tokyo with a mix of admiration and naked fear. It is the story of a nation that is simultaneously the world’s largest debtor and one of its most powerful creditors—and whose next political decision could send the global “carry trade” plunging into the abyss.
The Japan Paradox: Wealthy Abroad, Deep in the Red at Home
At first glance, Japan’s balance sheet looks like an economic nightmare. With public debt exceeding 250% of gross domestic product (GDP), the country stands alone at the top of the global debtor rankings, far ahead of any other industrialized nation. And yet Japan is not collapsing. Why? Because the country is a financial Janus.
Domestically, the state is heavily indebted—but its creditors are not impatient foreign investors. They are its own citizens, banks, and the central bank (the Bank of Japan, or BoJ). Externally, however, Japan appears as a giant: for more than 34 years it was the world’s largest creditor nation. Only recently did Germany narrowly overtake Japan for the number one spot, thanks to massive export surpluses and a weak yen. Still, Japan continues to hold trillions in U.S. government bonds and equities worldwide. Japan is like a billionaire who has enormous loans outstanding with his own house bank, while owning half the city outright.
The Current Situation: Fiscal Bazooka Meets Interest-Rate Anxiety
The current prime minister, Sanae Takaichi—the first woman to hold the office—has torn up the traditional playbook of Japanese politics. She is pursuing an aggressive fiscal policy that even overshadows the “Abenomics” of her mentor, Shinzo Abe.
Fiscal policy: Takaichi is betting on record spending for defense and social security to stimulate the economy. Critics call this “voodoo economics,” arguing that such spending will further fuel inflation while pushing an already extreme level of public debt even higher.
Monetary policy: This is where the real explosive material lies. Under Governor Kazuo Ueda, the Bank of Japan has begun cautiously raising interest rates (currently around 0.75%). Takaichi, however, is pressing for low rates to keep the debt mountain manageable. This conflict of objectives—government (spend!) versus central bank (curb inflation!)—is creating enormous tension in the foreign exchange market. The former weakens the yen; the latter strengthens it.
The Sword of Damocles: The Yen Carry Trade
If this tension were to resolve itself in a stronger yen, a massive unwinding of the so-called yen carry trade could follow. For decades, investors have borrowed cheap money in Japan (at nearly 0% interest) and invested it in the U.S. or Europe at much higher yields. It has been the lubricant of the global equity rally.
But this house of cards is wobbling. Should the BoJ unexpectedly accelerate the normalization of its monetary policy—or be forced to do so—the yen could appreciate sharply, triggering a “great repatriation” of capital. Japanese investors would pull money out of foreign markets, both to avoid currency losses and to benefit from higher interest rates at home. That would require large-scale sales of U.S. equities and bonds. The result would be a global market shock—similar to the “mini-crash” of August 2024, but potentially far more severe.
The Showdown on February 8: An Election as a Turning Point
The snap election this coming Sunday is far more than a domestic personnel decision.
Scenario: Takaichi victory. The LDP cements its shift to the right. Markets expect a continuation of loose monetary policy, weakening the yen but boosting export-driven companies (Toyota & Co.). The carry trade survives for now—but the risk of a later, uncontrolled blow-up increases.
Scenario: Opposition victory (CRA). The new center-right alliance calls for greater stability and faster interest-rate normalization. An opposition win would likely lead to an immediate and sharp appreciation of the yen and could trigger the unwinding of the carry trade on election night itself.
Conclusion
Japan stands at a historic crossroads. The country is attempting a high-wire act between massive domestic debt and its role as a global creditor, while the prime minister is openly taking risks. On February 8, it is not only Tokyo’s political future that will be decided—but possibly the direction of global financial flows for the rest of 2026 as well.
