Moody's rating staying put does not mean risks for Japan's stocks, bonds, and exchange rates have been eliminated. The $2.3 trillion fiscal blueprint is becoming the most critical variable.

The outlook for Japan's government fiscal expenditure in the trillion-dollar range has completely disrupted the trajectory of the Japanese stock market AI super bull market, as well as the tone of the bond and foreign exchange trading markets - leading to a significant increase in the 10-year Japanese government bond yield to 2.85% on Wednesday, ultimately reaching its highest level since 1996. However, at least for now, this has not changed the relatively positive and optimistic stance of one of the three major international credit rating agencies, Moody's Ratings, on the Japanese market. Moody's continues to maintain its "A1" rating for Japan with a "stable" outlook, indicating that there is no imminent downgrade impact on the Japanese government bond market in the short term, but this does not mean that bond market pressure has been relieved. The 10-year Japanese government bond yield has risen to around 2.865% - 2.88%, hitting a high not seen since 1996, and the 30-year yield has also climbed to around 4%, indicating that the core of market trading is not the rating being adjusted to any extent, but rather the fiscal expansion, inflation stickiness, depreciation of the yen, and the Bank of Japan's reduction of bond purchases jointly pushing up the term premium. Moody's latest stance reflects its continued recognition of Japan's stable growth, the nominal GDP expansion brought about by sustained inflation, and the likelihood of a slow decrease in the debt-to-GDP ratio. However, if the Abe administration's 370 trillion yen ($2.3 trillion) 14-year long-term investment plan lacks a clear source of funding, the bond market will still demand a higher risk premium. If Japanese government bond yields continue to rise and break through market psychological thresholds, coupled with sustained weakness in the yen leading to larger-scale foreign selling, growth stocks in the Japanese stock market that have been experiencing a super bull market this year, especially in the AI semiconductor theme sector with high valuations, are likely to come under pressure. On the other hand, banks, insurance companies, value stocks, and financial sectors benefiting from rising nominal interest rates may continue to have a relative advantage. In other words, Moody's stable rating for the Japanese stock market represents a "delay in risk repricing," rather than "elimination of risk repricing." Since the beginning of this year, the Japanese stock market, the Japanese government bond market, and the yen exchange rate have been "completely disconnected" - with continued large-scale inflows of foreign capital driving the Japanese stock market to new highs while the Japanese bond market and yen have struggled. Companies such as Yamaha, SoftBank, Socionext, Advantest, Toshiba, Tokyo Electron, Lasertec, Disco, Murata, and Taiyo Yuden, which together hold higher weights in the Nikkei 225 index, are the most important "narrative axis" of the recent large-scale inflow of foreign capital into the Japanese stock market. and the core contributing factor to the record-high gains in the Nikkei 225 index. Martin Petch, Deputy Head of the Sovereign Risk Department of this credit rating agency, did not sound the alarm regarding Japan's fiscal expenditure and debt expansion trajectory. However, he did acknowledge that Prime Minister Abe's unprecedentedly grand 370 trillion yen ($2.3 trillion) investment plan over 14 years requires clearer explanation. Petch said in an interview with the media on Wednesday, "At the current stage, we believe the credit rating is quite stable." Moody's has given Japan an A1 credit rating, which is its fifth highest investment-grade rating, and a "stable" outlook. "The risks are still very balanced," said Martin Petch. While Moody's temporarily maintains Japan's A1 credit rating and stable outlook, the key variable is the lack of clear funding sources for the 370 trillion yen investment blueprint that is now roiling the stock, bond, and foreign exchange markets, making government fiscal discipline a critical factor. Although Moody's temporarily maintains Japan's A1 credit rating and stable outlook, the 10-year Japanese government bond yield has risen to around 2.87%, reaching its highest level since 1996, and the market appears to be trading on the question of whether the fiscal expansion can be credibly financed, rather than just whether the rating will be downgraded. The greatest uncertainty surrounding this trillion-dollar investment plan may come from the lack of a clear funding source. While this presents significant risks to the Japanese stock, bond, and foreign exchange markets, Petch stated that it is still too early for Moody's to draw conclusions based on its credit assessment. Petch stated, "Our view on the rating will evolve." He also pointed out that the government's plan could change through a so-called "policy response function" - that is, when market concerns are reflected in higher borrowing costs or capital flows, officials may recalibrate their policy stance. This function was fully demonstrated this week. The government's annual economic policy agenda draft startled the financial markets because it gave the impression that the Abe administration was pressuring the Bank of Japan to slow down its rate hike. In response, officials adjusted the wording regarding monetary policy in the updated version. Currently, Petch and his team are focusing on factors they believe support Japan's credit situation, such as Japan's stable economic growth curve, ongoing inflation, and progress in reducing the debt-to-GDP ratio. According to a research report from July 8th, their data shows that this ratio will peak at around 219% in the 2020 fiscal year and decrease to below 195% by 2030. On the other hand, Petch pointed out that population aging and a significant increase in defense spending represent longer-term risks for the financial markets. The ratings representative also stated that if the government significantly deviates from fiscal discipline, the likelihood of a downgrade would greatly increase. A potential warning sign is if the government focuses more on recurring expenses to support short-term economic growth rather than measures consistent with long-term fiscal discipline. Investors are beginning to worry that this shift may already be underway. The latest government policy draft removed the classic term "fiscal consolidation" - a term that appeared in versions up to 2025. The market perceives this move as a weakening of the government's commitment to fiscal discipline. Petch also downplayed concerns that the Japanese government bond market would struggle to absorb debt issuances as the Bank of Japan continues to reduce its purchases of Japanese government bonds. Petch said, "We do see fiscal consolidation continuing on a gentle path, so the pressure should be manageable." From the most intense sell-off of Japanese thirty-year bonds to warnings of outflows in the Japanese stock market AI super bull market Moody's temporarily maintains Japan's A1 rating with a stable outlook, the core meaning is not "the disappearance of Japan's fiscal risk", but the rating agency still considers Japan's nominal growth, sustained inflation, and gradual decrease in the debt-to-GDP ratio as sufficient credit buffers to offset the short-term impact of fiscal expansion. What truly makes the market nervous is the policy mix itself: the Suga administration's proposal for a colossal 370 trillion yen /$2.3 trillion long-term investment plan over 14 years, covering 17 priority industries such as AI and semiconductor manufacturing, while at the same time, the Bank of Japan has raised its policy rate to around 1%, the government policy draft was interpreted by the market as an attempt to influence the pace of the central bank's rate hike, then had to adjust the wording to ease concerns about the central bank's independence. The 10-year Japanese government bond yield has risen to around 2.865% - 2.88%, reaching its peak since 1996, indicating that the bond market is questioning whether fiscal expansion can be credibly financed, rather than just the possibility of a downgrade. The selling pressure in the Japanese bond market has pushed the traditional low-interest rate fiscal model Japan has long relied on into a stress test. With Japan's government debt exceeding 200% of GDP, the implicit premise of sustainability in the past has been low inflation, low rates, and the central bank continuously absorbing government bond supply; but when the weak yen pushes up import inflation, the market demands higher term premiums, and the central bank is forced to push normalization forward, the rise in long-term Japanese government bond yields is no longer a "type of economic recovery benefit," but more like a "discount on fiscal risk." This also explains why the rise in yields has not effectively supported the yen: if the increase in rates comes from risk and term premiums rather than healthy rate hike expectations, the foreign exchange market will be concerned about fiscal dominance, policy constraints, and inflation stickiness, leading to a negative feedback loop of "Japanese bond decline - yen weakness - rising inflation expectations - central bank finding it harder to balance." For the Japanese stock market and the AI super bull market that dominates the country, the real risk is not the valuations themselves, but a marginal reversal in the funding structure. The significant rise in the Nikkei index has been largely driven by the continued expansion of demand around the AI computing industry chain, the export dividends from a weak yen, corporate governance reforms, and foreign capital inflows. The benchmark stock index of blue-chip stocks in the Japanese stock market - the Nikkei 225 index - has risen by about 35% so far this year, significantly outperforming major stock indices in the US, Europe, and China, with foreign investors continuing to net buy Japanese stocks by 1.08 trillion yen in the week ending May 23, marking the eighth consecutive week of net inflows. However, for investors focused on the Japanese stock market, the core issue is that the AI semiconductor market itself is highly dependent on foreign pricing, and once long-term rates continue to rise, yen volatility intensifies, global AI semiconductor crowded trades and leveraged positions cool down drastically, and foreign capital shifts from "marginal buyer" to "marginal seller," a dangerous structure similar to the late stages of the dot-com bubble of institutions withdrawing and domestic funds passively picking up the slack could be replicated. Recently, the Japanese stock market has seen the largest weekly net outflow of foreign capital since March, as a result of soaring long-term Japanese government bond yields, the yen hitting a 40-year low, profit-taking in highly crowded and leveraged tech stocks, and growing concerns about AI semiconductor valuations - these are more worthy of caution than mere discussions of price-to-earnings ratios. If the Suga administration can provide clear sources of funding, maintain expressions of fiscal discipline, and ensure that the Bank of Japan has policy room to withstand inflation, the Japanese stock market may still be supported by AI semiconductors, capital spending, financial stocks, and export leaders; but if the 10-year yield continues to approach or surpass 3%, and foreign investors continue to net sell Japanese technology and semiconductor assets, high valuation sectors in the Japanese stock market will face dual pressures of discount rates and capital outflows, and even potentially experience a sharp bear market similar to the intense decline seen during the 2000 dot-com bubble era.