Expectations of fiscal expansion rise as Shigeru Ishiba resigns, triggering a plunge in Japanese long-term government bonds and sending the 30-year bond yield soaring to a historic high.

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The sudden resignation of Japanese Prime Minister Shigeru Ishiba has heightened market expectations that the country's fiscal discipline may be relaxed, triggering a sharp sell-off of long-term Japanese government bonds.

On Monday, prices of long-term Japanese government bonds plunged, pushing yields higher. In particular, the yield on 30-year Japanese government bonds jumped 6 basis points, matching the record high reached last week. This further widened the yield spread with 5-year government bonds, a gap that has already far exceeded those of other major economies.

Investors generally believe that among the ruling Liberal Democratic Party, potential candidates to succeed Ishiba Shigeru are more inclined to adopt aggressive fiscal stimulus measures, which could lead to runaway government spending, thereby increasing the risk to long-term Japanese government bonds. According to overnight index swap (OIS) data, the market now expects the probability of the Bank of Japan raising interest rates in October to have dropped from over 50% last week to 21%.

Analysts warn that the turbulence in the Japanese government bond market is far from just a domestic issue. As one of the world’s largest holders of overseas assets, any fresh surge in Japanese government bond yields could trigger ripples and volatility across global bond markets.

Political Uncertainty Intensifies, Yield Curve Steepens

The political repercussions from the prime minister's resignation are reshaping the yield curve in Japan’s government bond market. On Monday, the 30-year government bond yield reached 3.285%, the 20-year yield rose 3.5 basis points to 2.670%, while the 40-year bond saw no transactions. The steepening of the yield curve reflects deep market concerns about long-term fiscal risks.

“The fact is, the ruling coalition of the Liberal Democratic Party and Komeito has lost its majority in both houses, so they have to cooperate with opposition parties calling for greater fiscal expansion,” said Shinichiro Kadota, Chief FX and Rates Strategist at Barclays Japan:

“Regardless of who eventually takes office, the yield curve is likely to further steepen. The only question is by how much.”

The next market focus will be the leadership election of the Liberal Democratic Party. The election is expected to be held in early October. At that time, whoever becomes the next prime minister will determine the direction of Japan's future fiscal policy.

The potential candidates currently emerging mostly support fiscal expansion. They include former Minister of Internal Affairs and Communication Sanae Takaichi, who came in second in last year’s leadership election and has consistently supported more stimulus. In addition, former prime minister’s son and current Minister of Agriculture, Forestry and Fisheries, Shinjiro Koizumi, may also enter the race. These potential leaders have reinforced market expectations that the future government will have more leeway to increase spending.

Short-Term Rate Expectations Cool Down, Expansive Policies May Become Mainstream

In a broader context, Japanese long-term government bonds—like their U.S., U.K. and European counterparts—are facing ongoing pressure from future inflation, heavy government debt burdens, and investor absorption capacity.

Takeshi Kanamaru, Senior Fixed Income Portfolio Manager at Manulife Investment Management Japan, said:

“The next government is very likely to roll out fiscal stimulus, and this has become a major concern for the Japanese government bond market. Unless the supply-demand imbalance changes dramatically, it is unlikely that long-term government bonds will see a significant rebound.”

In the coming weeks, a series of government bond auctions will test investor demand, including a 5-year bond auction later this week, followed by auctions for 20-year and 40-year bonds. Although Japan’s Ministry of Finance has announced a reduction in the issuance of super-long-term bonds, this may not be enough to ease investor concerns.

Risk Warning and DisclaimerThere are risks in the market; investment should be made cautiously. This article does not constitute personal investment advice and has not considered individual users’ specific investment objectives, financial situation, or needs. Users should assess whether any opinions, viewpoints, or conclusions in this article are suitable for their particular circumstances. Invest at your own risk. ```