Ahead of this weekend’s upper house elections in Japan, investors are worried that potential political shifts will further strain the fragile financial structure. This uncertainty has led to record interest rate increases, particularly on long-term Japanese government bonds (JGB).
Ahead of this weekend’s upper house elections in Japan, investors are worried that potential political shifts will further strain the fragile financial structure.
Ahead of this weekend’s elections, Prime Minister Shigeru Ishiba’s declining public support is jeopardizing the ruling Liberal Democratic Party’s (LDP) goal of retaining its parliamentary majority. According to an NHK poll, the party has fallen to its lowest approval rating since 2012. A poor result on Sunday could lead to a range of consequences, from changes to the coalition structure to Ishiba’s resignation.
Even in the most moderate scenario, spending-oriented policies are expected to prevail.While the three major opposition parties advocate for a reduction in consumption tax, the right-wing populist Sanseito party proposes the complete abolition of VAT. Within the LDP, Sanae Takaichi, known for her reflationary views, is one of Ishiba’s strong rivals for leadership.
In this environment, the 30-year JGB yield hit a record high of 3.20% on Tuesday, while the 20-year yield rose to 2.65% and the 10-year yield to 1.595%. Ales Koutny, head of international interest rate strategies at Vanguard, stated that Japan is on a path similar to that of the UK a few years ago: “Without fiscal discipline, the bond market will put economic pressure.” Japan’s public debt is the highest among developed countries, at approximately 250% of its GDP. The bond sell-off that began at the end of May led to sharp increases in super-long-term bonds. The 40-year yield rose to 3.51% this week. The Treasury is trying to correct the imbalance in the markets by reducing the issuance of 20-, 30-, and 40-year bonds. Minister Katsunobu Kato stated that he is closely monitoring the markets and will take steps to maintain confidence in debt management.
Bank of Japan‘s cautious approach to interest rate hikes and global economic uncertainties are leading investors to act cautiously. Asset Management One’s Kentaro Hatono said they are taking a “wait-and-see” approach due to the risk of a steepening yield curve after the election.
According to Barclays, the increase in 30-year interest rates is already pricing in a reduction in consumption tax from 10% to 7%. According to an Asahi newspaper poll, 68% of voters believe that tax cuts are the most effective solution to the rising cost of living. However, Ishiba prefers to proceed with cash stimulus rather than direct tax cuts. A weak election result could accelerate the sale of super-long-term bonds by life insurance companies and other large investors. According to Toshinobu Chiba of Simplex Asset Management, if the opposition wins, the budget deficit will increase significantly and the bond yield curve will steepen sharply.
