Japanese Prime Minister Sanae Takaichi faces a crucial market test this week as the finance ministry prepares to auction 700 billion yen ($4.5 billion) of 30-year government bonds on Thursday. This sale comes just days before a snap election, where Takaichi hopes a decisive victory will give her a mandate for expansionary fiscal policy. The auction is being closely watched as a barometer of investor sentiment towards Japan’s fiscal policies, particularly Takaichi’s pledge to suspend the consumption tax on food.
Auctions have become a focal point for investors concerned about Japan’s finances, which are the most indebted in the developed world, with debt at 230% of GDP. In four of the past five 30-year bond sales, yields have spiked to record highs either before or after the auction. Shoki Omori, chief desk strategist at Mizuho Securities, suggests demand will likely be weak and yields could spike, calling the auction “a referendum on how investors feel about the fiscal risks from the election.”
The term premium – the compensation investors demand for holding longer-term bonds – reflects these worries. Omori calculates the 30-year term premium at 2.8 percentage points, significantly higher than the 1.6 percentage points for 10-year Japanese Government Bonds (JGBs). Newspaper polls suggest Takaichi’s Liberal Democratic Party is poised for a significant victory, adding pressure to the bond markets. A 10-year note auction on Tuesday will also offer an indication of investor appetite for government debt.
While Japan’s sovereign bond market is predominantly funded by domestic investors, foreign accounts, especially hedge funds, are playing an increasing role in the longest-dated bonds. These investors exacerbate volatility in the market as traditional buyers remain sidelined. Chris Scicluna, head of research at Daiwa Capital Markets Europe, noted that foreign investors accounted for about 46% of trading in super-long cash JGBs in December, up from 13% the previous year.
