Explaining the Japanese bond-market rebellion that has the whole world on edge

• Japanese bond yields surged on Tuesday, sparking volatility in global markets.
• Prime Minister Sanae Takaichi's call for a snap election and proposed fiscal plans have fueled investor concerns.
• Rising Japanese yields may impact US and European rates as global investors react to volatility.

President Donald Trump's latest threats to hike tariffs on major European economies are shaking up markets on Tuesday, but a surge in Japanese bonds yields is also weighing on investor sentiment.

Japanese 40-year bond yields surged to 4.2% on Tuesday from 3.94% on Monday — the first time ever they've crossed the 4% mark. Yields started the year at 3.6%. Rates on 30- and 20-year bonds have also spiked.

In a note to clients on Tuesday, Jeffrey Favuzza, an equities trader at Jefferies, called the Tuesday sell-off a two-standard-deviation move lower. When yields rise, bond prices fall.

What's behind the volatility? A potential pause on food taxes.

On Monday, Japanese Prime Minister Sanae Takaichi called a snap parliamentary election set to be held on February 8. Takaichi's goal is to gain more support for her agenda — which includes a proposed 2-year break from the 8% tax on food products — in the new parliament.

The news has been too much for investors to swallow. Japan's government debt levels have already been a concern for markets, and investors fear such a tax holiday would exacerbate an already shaky fiscal situation.

As of 10:30 am ET, the S&P 500 was down 1.16%, while the Nikkei 225 had fallen 1.11%. Meanwhile, gold, which investors have increasingly seen as a hedge to the threat of global fiat currency debasement, was up 3.3%. The Japanese bond turmoil was part of a one-two punch battering markets, along with Donald Trump's increasingly aggressive rhetoric on Greenland.

"These moves highlight the extent to which investors are souring on this snap election that is promising a food sales tax holiday, which will only make a bad fiscal situation worse," David Rosenberg, the founder of Rosenberg Research, said in a note on Tuesday. "Since Takaichi took office in October, longer-term interest rates have jumped +80 basis points, with obvious spillover effects across the globe."

Rising Japanese bond yields have an impact on broader markets because of the country's outsize influence on global capital flows. Both domestic and foreign investors have used low yields to lever up positions in higher-yielding assets like US Treasurys and stocks.

With yields surging, Japanese investors could pivot away from US bond markets and simply buy domestic government debt. It also revives fears of an unwind of the "carry trade." Concerns about the carry trade have been on display in recent years, as investors fear an unwind of levered positions amid rising Japanese yields.

Yields on 30-year US Treasurys rose to 4.9% on Tuesday from 4.84% on Monday. Generally, higher long-term government bond yields tend to hurt equity performance as investors can get attractive returns on risk-free assets.

How things develop in Japan in the days ahead should be top of mind for investors, said Jean Boivin, head of the BlackRock Investment Institute, in a note on Tuesday.

"On a quieter data week, we are looking at what global flash PMIs say about global activity. Otherwise, the focus is on Japan where the expected snap election may pave the way for the ruling Liberal Democratic Party to pursue looser fiscal policy and add more pressure to global long-term bond yields," Boivin and his team wrote.

There are plenty of other things happening this week for investors to keep an eye on, too.

For one, Trump is speaking in Davos on Wednesday, perhaps offering another update to his approach to acquiring Greenland from Denmark. Trump may also join G7 leaders for dinner in Paris on Thursday, per an invite from French President Emmanuel Macron. Michigan Consumer Sentiment data is also out on Friday, which could provide a window into whether renewed tariff uncertainty is weighing on Americans' economic outlook.