Japanese Prime Minister Sanae Takaichi faces a crucial market test during the final stretch of this weekend's snap election campaign, as she seeks a decisive victory to secure a mandate for pursuing expansionary fiscal policies.
The Ministry of Finance will auction approximately 700 billion yen (equivalent to $4.5 billion) in 30-year government bonds on Thursday, just three days before the election.
This maturity is highly sensitive to concerns about looser fiscal discipline, having suffered a significant downturn last month when investors reacted negatively to Takaichi's pledge to suspend the food consumption tax.
Government bond auctions have become a focal point for investors to express anxieties about Japan's fiscal health, with the nation's debt burden reaching 230% of GDP, the worst among developed economies.
In four of the last five 30-year bond auctions, yields have surged to record highs either during the auction's preparation phase or immediately following the announcement of results.
This includes the bond market plunge on October 7, which occurred just three days after Takaichi secured the presidency of the ruling Liberal Democratic Party, effectively locking in her position as Prime Minister—Takaichi is viewed as a fiscal dove and a proponent of former Prime Minister Shinzo Abe's "Abenomics" policies.
Bond yields move inversely to their prices.
Shoki Omori, Chief Desk Strategist at Mizuho Securities, stated, "This auction essentially serves as a referendum on investor sentiment regarding the fiscal risks associated with the election."
"I believe demand is likely to be weak, as investors will remain cautious, and they have good reason to be cautious," Omori added, anticipating a potential yield spike after the auction.
These concerns are clearly reflected in the term premium, which is the additional compensation investors demand for holding long-term bonds. Omori noted that the calculated term premium for 30-year bonds is 2.8 percentage points, which is "significantly steeper" than the 1.6 percentage point term premium for 10-year Japanese Government Bonds (JGBs).
This is the first issuance of 30-year bonds since Takaichi announced the snap election on January 19 and pledged to suspend the consumption tax; with the latest polls indicating a potential major victory for her LDP, the bond market may remain tense.
An auction of 10-year bonds on Tuesday will provide an earlier indicator of demand for JGBs, although this maturity typically experiences smaller fluctuations due to its higher liquidity and broader investor base.
On Monday, the yield on the benchmark 30-year JGB hovered around 3.63%. While this represents a retreat from the historical peak of 3.46% recorded on January 20, it is still approximately 0.5 percentage points higher than its level in early October.
Japan's sovereign bond market is primarily funded by domestic investors, mitigating any substantial risk of capital flight.
However, overseas accounts—predominantly hedge funds—have been increasing their share of trading in ultra-long-term JGBs. Filling the void left by traditional buyers like life insurers and pension funds, they are amplifying volatility in this traditionally stable market.
The latest data from the Japan Securities Dealers Association shows that foreign investors accounted for approximately 46% of trading in ultra-long-term spot government bonds in December last year, a substantial increase from 13% a year earlier.
Chris Scicluna, Head of Research at Daiwa Capital Markets Europe, commented, "The participants in the ultra-long-term bond market are not long-term, buy-and-hold allocators, but rather speculative capital that moves in and out quickly." He added that the persistent decline in bond prices is causing domestic, hold-to-maturity investors to remain on the sidelines.
"Faced with such extreme volatility, nobody wants to catch a falling knife."
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