Japan approves ¥18.3 trillion supplementary budget, shifts bond issuance plan heavily toward short-term debt.

Japan approves ¥18.3 trillion supplementary budget, shifts bond issuance plan heavily toward short-term debt.

To fund the new round of economic stimulus plan, the Japanese government announced a debt issuance plan: there will be a significant increase in short-term bond issuance.

On Friday, Japan's cabinet approved an additional budget of 18.3 trillion yen to support Prime Minister Sanae Takaichi's economic stimulus package. According to a statement from the Ministry of Finance, 11.7 trillion yen will be raised by issuing new bonds.

To reflect this change, the Japanese government has revised this fiscal year's bond issuance plan. The Ministry of Finance announced an additional 300 billion yen of two-year government bonds and 300 billion yen of five-year government bonds, while greatly increasing the issuance of 6.3 trillion yen in Treasury bills. Meanwhile, plans to issue long-term and super-long-term bonds (10 to 40 years) remain unchanged.

This decision comes amid increasing concerns over Japan's fiscal discipline, pushing long-term bond yields to their highest in over twenty years. At Friday's government bond auction, markets showed a cautious attitude. As expectations for a Bank of Japan rate hike rise, demand for the two-year bond auction was weak, with yields climbing to 0.97%, the highest since 2008. This further highlights investors' wait-and-see stance under the dual pressures of policy shifts and new bond supply.

Financing Strategy Focused on Short-Term Debt

The core of this debt issuance plan is to focus on short-term debt to minimize the impact on the market. Finance Minister Katsuki Katayama explained in a statement that this year's total bond issuance is less than last year. The yields on two-year and five-year government bonds remain relatively stable and are expected to attract solid investor demand.

In contrast, yields on super-long-term bonds have been highly volatile since October, and yields on ten-year government bonds have recently risen. Given the increasingly thin demand for super-long-term bonds, the market generally expects the Ministry of Finance to rely on short-term bonds to fund the additional budget. Reportedly, primary dealers in previous meetings have also called on the government to increase the issuance of two-year, five-year, and ten-year bonds while reducing issuance of super-long-term bonds.

Kazuya Fujiwara, fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities, said:

"Given that the issuance volume may increase, investors may be reluctant to buy."

He added that investors are waiting to assess the details of the revised issuance plan after the Ministry of Finance's additional budget.

Fiscal Expansion Raises Market Concerns

Sanae Takaichi's expansionary fiscal policy has fueled external worries about fiscal discipline. Addressing voter anxiety over inflation while avoiding alarming investors is a key challenge for her government. Earlier this month, yields on Japanese long-term government bonds have reached their highest levels in over twenty years.

To demonstrate a "sense of responsibility" in fiscal policy, Takaichi has sought to emphasize fiscal discipline. She previously stated that the total bond issuance for this fiscal year would remain below last year's level. After including the new 11.7 trillion yen debt, total bond issuance for this fiscal year will reach 40.3 trillion yen, down about 4.3% from last year's 42.1 trillion yen.

Furthermore, Takaichi said Wednesday that IMF President Kristalina Georgieva told her at the recent G20 Summit that she was reassured Japan's potential fiscal risks were well managed. Aside from the new debt, funding for this stimulus plan will also come from 2.9 trillion yen in unexpectedly high tax revenue, 2.7 trillion yen in unused funds from the previous fiscal year, and 1 trillion yen in non-tax income.

Bond market sentiment is influenced not only by fiscal policy but also by the Bank of Japan's increasingly imminent policy shift. Friday's weak demand at the two-year government bond auction was an obvious reflection of this sentiment. The bid-to-cover ratio was 3.53, below the previous auction in October (4.35) and the twelve-month average (3.66). Another measure of demand, the "tail" (the gap between average accepted price and lowest accepted price) widened from 0.002 last month to 0.012, further indicating lackluster investor demand.

Behind weak demand at the auction is heightening market expectations for a short-term Bank of Japan rate hike. Overnight index swaps show traders now see a 57% chance of BOJ action next month, sharply up from 32% two weeks ago. The yield on the two-year government bond, highly sensitive to monetary policy expectations, has climbed to 0.97%, the highest since 2008.

Latest economic data also support rate hike expectations. Tokyo's inflation rate for November remained steady, while industrial output unexpectedly rose. Focus now shifts to Bank of Japan Governor Kazuo Ueda's speech next Monday. Amid ongoing fiscal concerns and inflationary pressure, investors will be watching closely for any signals regarding the timetable for monetary policy normalization.

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