Japan’s snap general election on February 8 pits prime minister Sanae Takaichi against skittish and formidable foes: the Japanese electorate and the bond market.
Takaichi is heading into the polls with an agenda of tax cuts and stimulus spending, hoping to woo voters in a country wrestling with rising prices and sluggish wage growth by promising to pursue “responsible fiscal expansion”. So far, her plans have buoyed her ratings.
But bond investors could prove much harder to convince. If she fails to persuade them that she can afford her plans, fund managers warn, the tremors will be global. In particular Japanese institutions, drawn to the surging yields at home, could start to repatriate capital from the rest of the world.
“Giant Japanese investors are getting increasingly incentivised to sell their overseas holdings and bring the money back home, and this is starting to hurt longer dated global bonds everywhere else in the world,” said Mike Riddell, a fund manager at Fidelity International.
This week, the difficult line Takaichi has to tread became apparent when she promised a two-year suspension of consumption tax on food — a measure that will cost the government an estimated ¥5tn ($32bn) — and 40-year yields crossed 4 per cent for the first time.
Any sell-off in the world’s third-biggest debt market, say fund managers, will become more acute the bigger the mandate Takaichi secures at the polls. “We are on the verge of seeing whether or not financial markets can really trust that Takaichi will be disciplined on the fiscal issue,” said one senior trader.
As yields rose this week, Japan’s finance minister Satsuki Katayama, speaking in Davos, noted that in 2025 it was estimated that “the general government fiscal balance-to-GDP ratio of Japan [at -0.6 per cent) will be the best among the G7 countries”.
She added that the country’s debt-to-GDP ratio could be reduced through a mixture of “wise spending” and “strategic fiscal measures” to boost potential growth.
Under the “Takaichi trade”, investors had bet that her government’s spending plans would weaken the yen, boost the stock market and send yields on long-dated bonds higher.
But “the Takaichi trade could be ending . . . as the ongoing increase of long-term yields could now be becoming negative for the economy and financial markets”, said Takahide Kiuchi, executive economist at the Nomura Research Institute.
The yen has slipped to levels at which the government has historically intervened, but taking action to support the currency could further boost yields.
“Takaichi’s stance on yen weakness is changing. The stance was they could accept it but now they want to defend it,” said Osamu Takashima, FX strategist at Citi, suggesting the prime minister may shift to backing the Bank of Japan interest rate normalisation after decades of ultra-loose policy.
“Hiking rates to defend the currency is a tough thing . . . to do, as it will only serve to counteract any growth from fiscal and the country could be stuck with higher funding [costs],” said Robert Dishner, senior portfolio at Neuberger Berman.
Long-dated yields have risen even though the Bank of Japan’s policy rate is still well below inflation at 0.75 per cent — a factor that should suppress yields on even longer-dated bonds.
The 40-year bond is not the only one to hit a record. In recent months, the benchmark 10-year JGB has risen well above 2 per cent for the first time in over a quarter of a century. Yields on 20- and 30-year notes have hit a succession of record highs.
After years of being anomalously low, JGB yields are becoming comparable with government debt elsewhere.
Thirty-year JGB yields have crossed those on equivalent German debt and are closing in on those of Spain’s. With that, investors are asking questions about sustainability that in recent years they have aimed at France, the UK and the US — but not Japan.
Japan’s gross debt, which has been as high as 250 per cent of GDP in recent years, means there are long-standing worries over the country’s finances. Some analysts say that, once government assets and domestic ownership of debt are taken into account, the picture is less grim.
Rating agencies are also relatively calm about the country’s debt levels so long as growth is healthy. “We are already taking into account a lot of the weakness on the fiscal front,” said Rain Yin, sovereign analyst at S&P Global Ratings.
But the idea of responsible fiscal expansion, said two Tokyo-based traders, evaporated as soon as the election was called.
As an ageing nation, neighbouring a more assertive China and ally to an unpredictable US, Japan may have few choices but to spend big.
Even before Takaichi became prime minister, Japan was planning to raise defence spending, and it is likely to go higher still; the country’s tariff deal with the US demands that Japan must underwrite $550bn of investment in America over the coming three years.
Takaichi’s tax pledge on Monday, said Barclays economist Naohiko Baba, marked a significant policy reversal: she had previously been firmly opposed to consumption tax cuts but, facing an election where opposition parties were making those exact pledges, changed course.
Some say Takaichi can weather any challenges. “She is not the one who has misunderstood the seriousness of the problem. She’s a policy geek and she thoroughly gets the issues at stake,” said CLSA strategist Nicholas Smith.
Still, analysts and traders will want to see how her campaign promises will translate into actual policy once votes have been cast.
“As an election strategy, the consumption tax cut is easy to understand for voters but, if it’s financed by a reduction in spending elsewhere or tax increase elsewhere, that’s another burden for ordinary people,” said Kiuchi at the Nomura Research Institute. “There is no free lunch.”
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