Concerns over fiscal expansion trigger heavy sell-off of Japan's long-term government bonds, with 20-year yield surging to highest level since 1999.

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Due to renewed concerns in the market over Japan’s fiscal situation, Japanese long-term government bonds faced heavy selling on Monday, pushing the 20-year government bond yield to its highest level in twenty-five years.

Meanwhile, the 30-year government bond yield rose 5 basis points to 3.26%, and the 40-year bond yield increased 5.5 basis points to 3.6%. This trend echoes last week’s sharp declines in US and UK bond markets, reflecting a rising global sensitivity among investors to government fiscal discipline.

At present, traders are focused on the actual scale of spending in Prime Minister Sanae Takaichi’s economic package. Although GDP data released on Monday showed an economic contraction, providing justification for Takaichi to introduce a stimulus package, the market remains wary that the government may depend even more heavily on fiscal policy to support growth.

This drop in government bonds highlights the delicate balance faced by policymakers: on one hand the need to boost a sluggish economy through fiscal spending, and on the other to address market concerns over fiscal sustainability, while the Bank of Japan still plans to raise interest rates in the coming months, making the policy environment more complex.

Stimulus Plan Scale in Focus, Fiscal Risk Premium Returns

The core uncertainty triggering this round of selling lies in the specific scale of the economic stimulus package soon to be announced by the Japanese government. According to Japanese media, the Takaichi government is considering compiling a supplementary budget that may exceed last year's level of 13.9 trillion yen.

"Investors are cautious about the scale of the government’s economic stimulus plan," said Naoya Hasegawa, Chief Bond Strategist at Okasan Securities:

"Uncertainty about the impact of the plan on government bond issuance is putting selling pressure on long-term bonds."

Market analysis suggests that concerns over Japan's fiscal situation are driving a resurgence in risk premiums. Goldman Sachs pointed out in a report that as investors grow increasingly wary of a larger-than-expected stimulus plan, Japan's fiscal risk premium is climbing again, putting pressure on long-term sovereign bonds and the yen. This trend reflects Takaichi’s approach of “responsible expansionary fiscal policy”, indicating her readiness to rely further on fiscal measures to support economic growth.

The current political background and market sentiment are causing investors to worry about Wednesday's upcoming 20-year government bond auction. Market participants will closely watch the results to gauge the strength of demand for Japanese long-term bonds after the spike in yields. If auction results disappoint, it could further intensify selling pressure in the market.

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