Japan faces a critical market checkpoint this week as the finance ministry prepares to offer about 700 billion yen ($4.5 billion) of 30-year government bonds on Thursday, three days before voters go to the polls in a snap election this weekend. The sale comes as Prime Minister Sanae Takaichi seeks an electoral mandate for expansionary fiscal measures, including a pledge to suspend the consumption tax on food that has unsettled fixed income investors.
Thirty-year paper has proven particularly reactive to concerns about a loosening of fiscal discipline. In recent months that tenor has experienced pronounced volatility, with four of the last five 30-year auctions seeing yields spike to fresh record highs either ahead of or immediately after the sales. Market participants point to the cash market’s sensitivity to fiscal signals as the reason long-dated yields often move before or after auctions.
That sensitivity was on view last October, when a sharp selloff in long-dated bonds occurred on October 7 - just three days after Takaichi, known as a fiscal dove and an adherent of the late premier Shinzo Abe’s "Abenomics" approach, won the ruling Liberal Democratic Party’s leadership contest and positioned herself to become prime minister. Bond yields move inversely to prices, and the recent pattern of selloffs has placed auctions at the center of investor scrutiny.
"This auction essentially serves as a referendum on how investors feel about the fiscal risks from the election," said Shoki Omori, chief desk strategist at Mizuho Securities. "I would say demand at the auction is likely to be on the weak side, because investors are going to be cautious. And they have a right to be," Omori added, noting that yields could spike following the sale.
The strain in long-dated debt is reflected in the term premium investors demand to hold longer maturities. Omori calculated the 30-year term premium at 2.8 percentage points, which he described as "way steeper" than the 1.6 percentage points for 10-year JGBs. That gap illustrates the extra compensation buyers require for locking in exposure over three decades amid uncertainty about fiscal policy.
Markets will get an earlier read on demand with an auction of 10-year notes on Tuesday. The 10-year sector is more liquid and attracts a broader set of buyers, which has historically made it less prone to sudden swings than super-long issuance. Still, the outcome of the shorter-dated sale will be watched for signs of whether investors are stepping back from government paper or maintaining a baseline appetite.
The benchmark 30-year JGB yield hovered at 3.63% on Monday - down from the record high of 3.46% on January 20, but still up about half a percentage point from where it was at the start of October. While Japan’s sovereign market is overwhelmingly funded by domestic investors and is not at real risk of capital flight, the composition of trading at the longest maturities has shifted, amplifying price swings.
Offshore accounts - predominantly hedge funds - are increasing their presence in the super-long segment, filling gaps left by traditional buyers such as life insurers and pension funds. Activity by these faster-moving investors has raised volatility in a market that has historically been more placid.
Data from the Japan Securities Dealers Association show foreign investors accounted for about 46% of trading in super-long cash JGBs in December last year, up from 13% a year earlier. "At the super-long end, it’s not real money investors in there. It’s fast money," said Chris Scicluna, head of research at Daiwa Capital Markets Europe, adding that the persistent slide in prices was keeping Japanese buy-and-hold investors sidelined.
Scicluna cautioned on the difficulties of returning to the market amid heightened moves. "When you’ve seen such significant volatility, you don’t want to be the one to try and catch a falling knife," he said, describing why entrenched domestic investors have been reluctant to re-enter positions amid large price swings.
As markets absorb the prospect of expansionary fiscal steps tied to the election, the Thursday auction of 30-year bonds will be treated as a test of investor conviction. If demand proves weak or yields spike, it will underscore the sensitivity of Japan’s super-long yields to political signals. Conversely, a calmer sale would suggest a degree of investor tolerance for the fiscal proposals under discussion.
Japan’s public debt remains a central feature of market calculations, with total debt at 230% of gross domestic product cited by investors as a backdrop to caution. The coming auctions, and how investors receive them, will be closely monitored for what they reveal about market confidence in the near-term fiscal path.
$1 = 154.8600 yen
Clear summary
Japan will auction 700 billion yen of 30-year government bonds three days before a snap election that Prime Minister Sanae Takaichi called after pledging to suspend the consumption tax on food. Long-dated yields have been highly sensitive to fiscal risk signals, with recent auctions triggering record-high yields and increased volatility as offshore hedge funds expand their footprint in super-long JGBs.
Key points
- The finance ministry plans to sell about 700 billion yen of 30-year JGBs on Thursday, three days before polls open.
- In four of the past five 30-year auctions, yields spiked to fresh record highs either in the run-up to or immediately following the sales.
- Foreign participation in super-long JGB trading rose to about 46% in December from 13% a year earlier, increasing volatility in that segment.
Risks and uncertainties
- Investor appetite at the 30-year auction may be weak, increasing the risk of a post-auction spike in yields - this would affect fixed income markets and could pressure long-term borrowing costs.
- Growing activity from offshore accounts, predominantly hedge funds, at the super-long end could exacerbate price volatility and deter traditional domestic buyers like life insurers and pension funds.
- Uncertainty about fiscal policy tied to the election - including the proposed suspension of the consumption tax on food - is a source of market nervousness and could influence demand across Japan’s sovereign debt market.
Tags: bonds, Japan, election, yields, JGBs