As a result of the Iran War, investors are now demanding greater compensation for holding government debt. This comes after more than a decade of ultra-low yields on government bonds that fueled an economic expansion. The forces driving this repricing begin at the Strait of Hormuz, where the war has turned an energy shock into a monetary shock.
That shock has now reached Japan’s bond market and the cost of financing American power itself.
The Strait of Hormuz sits at the intersection of energy dependence and financial vulnerability. Around a fifth of global oil passes through it, largely to Asia. Since the U.S.-Israeli war began in late February, tanker traffic has collapsed: from 130 transits to single digits by August. The International Energy Agency calls the shock unprecedented, with Gulf producers losing over 1 billion barrels by May.
Japan is exposed, with 95.1 per cent of crude imports from the Middle East in January 2026 and 73.7 per cent transiting Hormuz. Its crude import price is now 84.7 per cent above a year earlier. Tokyo released 80 million barrels from its strategic reserve and expanded fuel subsidies. Crude at $90-$100 a barrel could widen Japan’s annual trade deficit, weakening the yen and pushing up interest rates. Higher yields and yen appreciation reduce the incentive to buy U.S. Treasury bonds, while rapid unwinding could force foreign-asset sales, transmitting Japanese tightening into global bond markets. The oil shock has thus intensified inflation, accelerated monetary normalization, and threatened Treasury demand.
This matters globally because Japan’s retreat from ultra-cheap money removes a mechanism that kept capital inexpensive as governments and corporations demand more of it. This is altering the financial relationships through which America obtained cheap capital, turning an energy disruption into a test of U.S. borrowing costs as fiscal pressures intensify.
The scale of the problem keeps outrunning the response. On August 20, the U.S. Treasury doubled its ceiling for buybacks of long-dated securities (bonds maturing decades from now) to $4 billion per operation, after the 30-year Treasury yield topped 5.2 per cent, its highest since the 2007-09 Great Recession. That turned out not to be enough. On September 9, with the 30-year yield pushing to a 19-year high, the Treasury tripled the ceiling again, to $6 billion per operation.
Against a $32 trillion Treasury market, however, even $6 billion per operation is a feeble attempt at stabilization, not a solution to a market increasingly demanding higher compensation for holding U.S. government debt. Two escalations within three weeks say more about the trajectory of the problem than either intervention says about its solution.
The Fiscal Price of American Power
The arithmetic is stark: US federal debt has surpassed $40 trillion, annual interest costs are approaching $1.2 trillion, and the deficit has reached $1.8 trillion in the first 10 months of the fiscal year. Moody’s removed Washington’s final triple-A rating (the highest possible credit grade) in 2025, following S&P in 2011 and Fitch in 2023. None triggered a Treasury rout, as US market depth and liquidity remain unmatched, but each weakened the assumption that fiscal profligacy is cost-free for the world’s principal reserve currency. Higher yields raise interest costs, widening deficits and requiring further borrowing at higher rates.
This is not a solvency crisis since the United States borrows in its own currency and retains reserve-currency privileges (being the world’s default currency) that no competitor can easily replicate. But it constrains a country accustomed to financing its military and alliances cheaply. The era of cheap hegemony is over, and additional weapons programs and deployments now carry greater opportunity costs than five years ago, when Fed policy radically reduced the extra compensation investors demand to hold long-term bonds rather than, say, increase bond supply through “quantitative easing” or deficit-financed borrowing.
This strengthens the realist scholar Stephen Walt’s case for a more discriminating foreign policy, preserving intervention where vital interests are at stake without treating permanent military primacy everywhere as an end in itself. As Walt puts it, “the risk of underreaction must be weighed against the opposite danger of overcommitment.”
A Wider Contest for Capital
The sell-off is not confined to the United States. British government bonds have reached their highest yields since 1998, French borrowing costs have returned to 2008 levels, and German Bund yields have climbed back to 2011 levels. This is synchronised repricing: the Hormuz crisis coincides with a bond market already strained by heavy fiscal supply. An oil shock forcing Japan towards tighter policy matters more when developed-world governments are simultaneously competing for capital. This is not so much a shortage of borrowers but a shortage of cheap capital: governments are competing with one another and increasingly with corporations for the same global savings. Defense spending, energy security, industrial policy, and demographic pressures are expanding sovereign financing needs as post-2008 suppression of long-term yields recedes.
China, for now, faces similar pressures from the opposite direction. It still has ample room to finance an approximately $1 trillion program to expand industrial capacity, even as Washington and Tokyo face higher borrowing costs. But that advantage may be less durable than it appears. China already produces far more goods than its households can absorb, while consumer demand remains exceptionally weak. Higher oil prices from the Hormuz disruption could make that imbalance worse by squeezing household purchasing power even further. Public-sector debt has also risen to roughly 127 percent of GDP, while falling bank profitability is collapsing property prices (and with it, more than two-thirds of Chinese household wealth) and making it harder to keep channelling ever more money into productive investment.
This leaves an overemphasis on exports as the only escape valve, pushing excess production and the costs of China’s looming adjustment onto the rest of the world. This is the emerging global asymmetry: China still has access to unusually cheap domestic capital, getting cheaper by the day as its productive uses evaporate, while the rest of the major economies are discovering that capital has a price.
That imbalance will matter more as the world enters simultaneous fiscal expansion and industrial investment. Pressure also comes from the global AI buildout, creating enormous demand for long-duration capital as governments compete for funds. Morgan Stanley expects global AI-related debt issuance to reach almost $570 billion in 2026, more than twice 2025’s level. The five largest hyperscalers (companies that build and run massive cloud data centers) had issued $159 billion of debt by mid-year, exceeding all of 2025. The global bond market is therefore being asked, simultaneously, to finance sovereign deficits, military rearmament, and the largest technology investment cycle in decades. Treasury yields may need to remain elevated to compete with corporate debt financing and AI-driven growth. The repricing is visible in credit markets: Meta’s latest data-center financing, for a nearly one-gigawatt El Paso facility, has been priced at wider spreads (a bigger risk premium is being charged) than a comparable deal nine months earlier. Investor capacity, rather than company-specific risk, may now be setting the marginal price of AI debt.
The Limits of Exorbitant Privilege
The dollar’s reserve status, what French finance minister Valéry Giscard d’Estaing called its “exorbitant privilege,” provides substantial insulation, but that advantage has become ever thinner. The dollar accounted for 57.13 percent of allocated global foreign-exchange reserves in the first quarter of 2026, down from more than 70 per cent around the turn of the century. To be sure, it remains on one side of 89 percent of global foreign-exchange transactions, while the renminbi represents only a low single-digit share of reserves. Displacement remains gradual, but erosion matters for the trajectory of American actions.
Former IMF chief economist Kenneth Rogoff’s Our Dollar, Your Problem warned that dollar dominance, inherited partly through good fortune rather than sound performance, leaves America exposed to its own excesses even as it grants Washington singular financial power.
MIT’s Barry Posen argues that America’s geography and relative power allow it to discriminate among overseas commitments rather than treat every conflict as a test of credibility. The implication is not isolationism but selectivity: preserving core alliances and deterrence, asking wealthy allies to assume greater responsibility, and giving diplomacy greater weight. Rising borrowing costs increase the opportunity cost of weapons programs and open-ended deployments.
There are domestic implications as well. Durable power also requires more than military spending. Public investment helped build America’s technological leadership. Sustaining that capacity therefore requires investment in infrastructure, energy, science, education, and industrial capacity, rebuilding the productive foundations of a prosperous society rather than relying on ever greater military expenditure to sustain American hegemony.