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Japan’s government bond market, long shielded by the Bank of Japan’s yield curve control and decades of deflation, faces a test of faith under Sanae Takaichi, who is set to be the country’s first female prime minister.
Markets are betting that Takaichi, who won the race to lead Japan’s ruling Liberal Democratic Party on Saturday, will blend a pro-growth, fiscally active agenda with a still-dovish central bank: a mix that threatens to push long-term yields higher and steepen the Japanese government bond curve.
The parliament is expected to confirm the hardline conservative as prime minister on Oct. 15. Takaichi is seen as a proponent of “Abenomics,” the economic strategy of the late prime minister Shinzo Abe, which touted fiscal spending, loose monetary policy and structural reforms.
Goldman Sachs said that Takaichi’s win presents “upside risks to long-end JGB yields”, calling a 10- to 15-basis-point pop in 30-year yields a plausible first step.
The bank’s analysts added that the long-term Japanese government bonds have been “decoupled from cyclical anchors” this year, such as inflation or economic growth, and could stay elevated as investors price the risk of looser fiscal policy and a slower BOJ hiking cycle.
A BOJ rate hike expected in October by investors now looks uncertain. Deutsche Bank exited its long-Japanese Yen trade following the LDP election outcome, citing “too much uncertainty around Takaichi’s policy priorities and the timing of the BOJ hiking cycle.”
Japan’s 30-year bond yield jumped over 13 basis points to 3.291% on Monday, hovering near the all-time high notched last month. Its yields surged more than 100 basis points this year, data from LSEG showed.
The yield on the 20-year debt is at 2.7%, hovering at its highest level since 1999.
“That is a warning that the bond vigilantes are watching, and any effort to open up the fiscal floodgates, if you will, in ways that Takaichi has talked about because she loves Abenomics, is going to unnerve the bond market,” warned long-time Japan watcher William Pesek.
Takaichi wants a so-called “high-pressure economy,” using public-private investment and aggressive fiscal support to break Japan’s lingering deflation, said Crédit Agricole-CIB’s economists.
While Japan’s inflation has exceeded the BOJ’s target of 2% for more than three years, the government has yet to formally declare an end to deflation—a term it uses to describe a prolonged period of stagnation marked by weak wage growth and sluggish consumer spending.
The goal of a “high-pressure economy” is to shift companies from hoarding cash through cost-cutting to investing more for growth, reversing Japan’s unusually high corporate savings rate and easing long-term deflationary pressures, Crédit Agricole-CIB said. It added that the government is expected to make large-scale investments in designated important materials and technologies.
Takaichi’s economic policies could exacerbate Japan’s inflation problem and rattle Japan’s bond vigilantes if she trades tax cuts and handouts for opposition support, warned Pesek.
Japan’s stock market may cheer for now, but if Japanese government bond yields climb toward 2% or even 3%, it will lead to a “very interesting battle between Tokyo and the bond vigilantes,” he added.
Heightened volatility in long-term Japanese government bonds has turned Japan into a “net exporter” of bearish shocks to global long-end bonds this year, said Goldman’s interest rates strategy team.
Long-dated borrowing costs around the world have been under pressure several times this year, with market watchers owing it largely to investor unease with the path of both fiscal and monetary policy in many major economies.
“Our spillover estimates imply that a 10bp idiosyncratic JGB shock typically translates to 2-to-3bp of upward pressure onto US, German, and UK yields, suggesting risk of modest yield upside across other core sovereign bond markets in the coming days,” the bank’s team led by Bill Zu wrote.
