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Long protected by the Bank of Japan’s yield curve management and decades of deflation, the Japanese government’s bond market is facing a test of faith under Ahane, the country’s first female prime minister.
The market bets Takagi, who won the race to lead Japan’s ruling Liberal Democrats on Saturday, will blend a financially active agenda and blend a mix that still dvish central bank: boosts long-term yields and threatens to rush the Japanese government’s bond curve.
The Congress is expected to confirm the tough conservatives as prime minister on October 15th. Kochi touted the economic strategy, fiscal spending, loose monetary policy and structural reforms of the late Prime Minister Abe Shinzo, a supporter of Abenomics.
Goldman Sachs said Takachi’s victory would bring “a rise risk to long-end JGB yields,” and calling 10-15 Basis Point Pop in 30 years would win a plausible first stage.
Bank analysts added that long-term Japanese government bonds, such as inflation and economic growth, are “detached from the cyclical anchor” this year, and that investors can continue to rise as they price more looser fiscal policy risks and lower BOJ hiking cycles.
The BOJ rate hikes investors expect in October now look uncertain. Deutsche Bank has concluded the Japan-China yen trade following the results of the LDP election, citing “too much uncertainty regarding Takachi’s policy priorities and timing of the BOJ hiking cycle.”
Japan’s 30-year bond yield increased its 13 basis points to 3.291% on Monday, hovering with the highest notch ever in history last month. Data from LSEG shows that yields have skyrocketed by more than 100 basis points this year.
The 20-year debt yield was 2.7%, hovering at the highest level since 1999.
“It’s a warning that bond vigilantes are watching, and an effort to open the fiscal floodgates would hamper the bond market in the way she spoke about her love for Abenomics if she did,” warned Japanese watcher William Peche.
Takato hopes for a so-called “high-pressure economy” that uses public-private investment and aggressive financial support to break Japan’s lingering deflation, said an economist at Credit Agricol Tibe.
Japan’s inflation has surpassed the BOJ’s 2% target for over three years, but the government has yet to formally declare the end of the DEFL.
The goal of a “high-pressure economy” is to invest companies from cash storage through cost reductions to grow, reversing Japan’s unusually high corporate savings rates and alleviating long-term deflationary pressures, Credit Agricol Chib said. The government added that it is expected to make large-scale investments in designated critical materials and technologies.
Kochi’s economic policies could exacerbate Japan’s inflation problem and rattle Japanese bond vigilantes.
Japan’s stock market may support it for now, but he added that if Japanese government bonds rise to 2% or 3%, it will lead to a “very interesting battle between Tokyo and bond vigilantes.”
According to Goldman’s interest rate strategy team, the expanded volatility of long-term Japanese government bonds has been transformed into a “net exporter” of bearish shock to the world’s long-term bonds this year.
The cost of borrowing worldwide has been under pressure several times this year, as market watchers are making investors uneasy about both fiscal and monetary policy paths in many major economies.
“Our spillover estimates imply that a 10-bp specificity JGB shock typically leads to a 2-3bp upward pressure on US, Germany and the UK, suggesting the risk of modest yields across other core sovereign bond markets over the coming days.”
