Japan bond markets react to Takaichi Sanae’s stimulus push

Japan’s government bond market is being hit with its biggest test in decades after Takaichi Sanae secured the leadership of the ruling Liberal Democratic Party on Saturday, according to data and comments provided by Goldman Sachs, Deutsche Bank, Crédit Agricole-CIB, William Pesek and ING strategists.

Takaichi is on track to become Japan’s first female prime minister on October 15. For years, the Bank of Japan held yields down with strict yield curve control while deflation muted investor worries. Takaichi’s plan to combine heavy government spending with a still-dovish central bank is now seen by traders as a direct trigger for higher long-term yields and a steeper bond curve.

Takaichi has built her program on the late Prime Minister Shinzo Abe’s Abenomics, which relied on fiscal spending, loose monetary policy and structural reforms.

Goldman Sachs said Takaichi’s win creates “upside risks to long-end JGB yields,” calling a 10 to 15 basis point rise in 30-year yields a realistic first step. Analysts at the bank said Japanese government bonds this year have been “decoupled from cyclical anchors” like inflation and growth and may stay high as investors prepare for bigger public spending and a slower BOJ hiking cycle.

Markets move on BOJ policy doubts and bond vigilante warnings

Expectations for an October Bank of Japan rate hike have faded. Deutsche Bank exited its long-Japanese yen trade right after the LDP vote, citing “too much uncertainty around Takaichi’s policy priorities and the timing of the BOJ hiking cycle.”

Yields responded quickly. Japan’s 30-year bond yield jumped over 13 basis points to 3.291% on Monday, near the record reached last month. LSEG data shows it has climbed more than 100 basis points this year. The 20-year debt yield stands at 2.7%, its highest level since 1999.

William Pesek, a veteran Japan analyst, warned, “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.”

Takaichi targets high-pressure economy and global ripple effects

Economists at Crédit Agricole-CIB said Takaichi wants a “high-pressure economy” built on public-private investment and large fiscal support to end Japan’s lingering deflation.

Japan’s inflation has stayed above the BOJ’s 2% target for over three years, but the government still has not formally declared an end to deflation, which it defines as weak wage growth and slow consumer spending. Crédit Agricole-CIB said the goal is to move companies away from cash hoarding and cost-cutting and push them toward investing for growth.

This could reverse Japan’s unusually high corporate savings rate and reduce long-term deflationary pressure. The government is expected to fund major projects in key materials and technologies as part of this plan.

Pesek also warned that if Takaichi trades tax cuts and handouts for opposition support, her policies could worsen Japan’s inflation problem and unsettle the bond vigilantes. “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 said.

Goldman Sachs’ interest rate strategy team noted that increased volatility in long-term Japanese government bonds has made Japan a “net exporter” of bearish shocks to global long-end bonds this year.U.S. Treasury yields also reacted during Asian hours as the U.S. government shutdown continued.

ING rates strategists wrote, “Whilst we foresee the 10-year U.S. Treasury yield finding its way higher towards 4.5% from a structural perspective, we do think the shutdown will prevent that move from materializing for now.”

The strategists added they do not expect the 4% level to break on the downside without stronger data. A $58 billion auction of three-year Treasury notes will start this week’s Treasury sales. The two-year Treasury yield fell 0.7 basis points to 3.589%, and the 10-year Treasury yield dropped 1.2 basis points to 4.149%, CNBC data shows.

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