Sanae Takaichi, elected Japan’s first female prime minister in October – JIJI Press/AFP
New Japanese prime minister Sanae Takaichi has sent fresh tremors through her country’s bond market, raising fears of a “Liz Truss moment” and evoking comparisons with Rachel Reeves.
On Friday, the leader of the world’s fourth largest economy unveiled a ¥21tn (£103bn) package of tax cuts, cash handouts and industrial subsidies – which will add to a government debt pile that is already 237pc of the country’s GDP.
Investors sold off Japan’s long-term government bonds this week ahead of her announcement, propelling yields to multi-decade, even record, highs.
The yen has also dropped to near its lowest this year. And completing the trifecta, the Tokyo stock market has been under pressure – traders are worried the Bank of Japan will need to raise interest rates soon to fight sticky inflation, even as the economy slows.
For Japan, it marks an upending of the established order. While the country has suffered from long running stagnation, its relative financial stability has helped keep volatility in the bond market in check. But not any more.
“Markets are likely to remain wary of the risk that Japan could face a sharp concurrent decline in bonds and currency, as experienced by the UK in 2022,” they said.
Under Liz Truss, UK borrowing costs leapt from 3.4pc when she took the premiership to almost 5pc later that month – Jacob King/PA
Mark Dowding, the chief investment officer at RBC BlueBay Asset Management, said in a note that his meetings with some of Japan’s largest investors in the past week had uncovered “widespread concern at the Takaichi agenda”.
There was “a concern that a ‘sell Japan’ trade could build in the days and weeks ahead, if there is no course correction”.
This echoed fears among investors in British bonds, who were rattled last week by the Chancellor’s about-turn over income tax.
Dowding said: “If Sanae Takaichi seems to be making her own problems, the same would also appear to be true of Rachel Reeves in the UK”.
Japan’s benchmark 10-year government bond yield hit 1.81pc on Thursday – the highest in 17-year highs. The longer dated 20-year bond also hit at a 26-year high of 2.84pc, while the 30-year yield of 3.36pc and 40-year yield of 3.72pc were also records.
Takaichi came to power in October after a spell of high inflation fuelled discontent with her predecessor, Shigeru Ishiba. This led to their Liberal Democratic Party losing ground in an upper-house parliamentary election in July.
Her package on Friday includes raising income tax thresholds, cutting petrol taxes, boosting subsidies for household energy bills, and expanding grants to help with shopping bills.
She is also pumping money into shipbuilding, semiconductor and space projects, alongside healthcare, defence, and disaster preparedness.
The economy shrank 0.4pc in the third quarter. Declining exports were partly to blame, but cost-battered consumers also spent less.
Takaichi will be hoping her spending package revives consumer spending and the economy. But it could also trigger an inflation breakout. Japan’s statistics bureau on Friday said inflation in October had ticked back up to 3pc.
George Saravelos, a Deutsche Bank analyst, said the government was risking a bigger rush towards the bond market’s exit door.
“It is stability in inflation expectations that ultimately keeps the whole system together. If domestic confidence in the government’s and Bank of Japan’s commitment to low inflation is lost, the reasons to buy Japanese government bonds disappear, and more disruptive capital flight ensues,” he said.
“We will be watching for signs of broader capital flight in Japan’s markets closely in coming weeks.”
Unlike Reeves and Truss, Takaichi has enough fiscal headroom to avoid running a budget deficit this year – even after her new package.
Still, her government will need to issue more bonds to cover the cost of the new stimulus, just at a moment when domestic Japanese investor appetite for government debt – which accounts for more than 90pc of demand – is falling.
The Bank of Japan, which holds about half the Japanese government bonds on issue, is buying less than half its previous amount as it winds back its holdings. New regulations have also reduced life insurers’ requirement to buy or hold long-dated bonds.
“Bond issuance has been quite strong even before the announcement of the large supplementary budget. A shortfall in demand will keep the very long end of the curve volatile,” said Marcel Thieliant, of Capital Economics.
Rising yields may attract some foreign investors. But Barclays suggested they may be wary of a country without an independent budget watchdog.
“The lack of a third-party fiscal assessment body in Japan is another concern, as former UK prime minister Truss’s lack of engagement with the UK Office of Budget Responsibility exacerbated the gilt markets’ fiscal concerns,” the bank’s analysts said.
Deutsche’s Saravelos said the amber warning sign would be an ongoing decoupling of Japanese yields from those of other rich-country sovereign bonds.
It’s a similar story in Britain, where investors demand higher yields to hold UK debt than that of Italy or France.
Reeves and Takaichi may not be ideological bedfellows – but they are both in the bond vigilantes’ sights.
