Market temporarily eases fiscal concerns, Japanese ultra-long-term government bonds continue to rebound

Japanese super-long government bonds continued to strengthen after the election. Sanae Takaichi’s cautious stance on the food consumption tax reduction plan eased investors' concerns about fiscal policy and pushed yields further down.

According to Bloomberg, the 40-year Japanese government bond yield dropped by 10 basis points, while the 30-year yield dropped by 9.5 basis points, falling back to levels close to early January, extending the post-election rebound.

The key to the market reaction lies in Sanae Takaichi's latest statement. At her first press conference after winning the election, she mentioned concerns over the two-year food consumption tax reduction plan, and talked about the goal of increasing defense and strategic industry spending. However, she did not make a strong commitment to lowering the food consumption tax, easing bond market vigilance regarding fiscal sustainability.

Meanwhile, the yen has strengthened against the U.S. dollar for three consecutive trading days this week, but Japan's top foreign exchange official Atsushi Mimura said Thursday that the government has not relaxed its vigilance. While investor sentiment improves, the market is still assessing how the funding gap will be “sustainably” filled if tax reductions are pursued without new bond issuances.

Super-long yields fall, post-election rebound continues

In the previous weeks, concerns over fiscal sustainability had caused sharp volatility in super-long government bonds. Bloomberg stated that as yields fall back to levels close to early January—when the news of Sanae Takaichi running in the election was first reported—the market’s pricing of “tail risks” is converging.

This round of decline is concentrated at the long end, with the rapid drop in 30- and 40-year yields reflecting funds flowing back to longer maturities that are more sensitive to fiscal expectations.

More restrained policy signals, worries on tax reduction and bond issuance temporarily eased

Bloomberg notes that one interpretation of Sanae Takaichi's victory by the bond market is that the political outcome may bring clearer policy paths, reducing the likelihood of extreme fiscal policy scenarios.

On the statement front, Sanae Takaichi admitted concerns about the food consumption tax reduction, but emphasized that the Ministry of Finance will not fill the spending gap by issuing new bonds, instead will review subsidies, special tax regimes, and non-tax revenues to find what she calls “sustainable” funding sources.

Her lack of a strong commitment to lowering the food consumption tax is also seen by the market as a sign of alleviating pressure from new supply in the short term.

Institutional opinions: High yields attract reestablishment of long positions, interest rates may continue to decline

Ryutaro Kimura, Senior Fixed Income Strategist at AXA Investment Managers Ltd., said that Sanae Takaichi's lack of a strong commitment to lowering the food consumption tax has given bond investors "a strong motivation to restore long positions in super-long Japanese government bonds."

These bonds previously offered "historically high yields." He also stated that the downward trend in super-long interest rates “may continue for some time.”

This viewpoint aligns with market trends—after marginal easing of policy uncertainties, funds are more willing to rebuild long-end positions that had contracted due to volatility.

Tail risks remain: If tax reduction advances, how to fill the funding gap

Despite improved market sentiment, Bloomberg pointed out that investors remain vigilant about the possibility of renewed sharp market volatility.

The reason is that even without issuing new bonds to fill the gap, if the government aims to cut sales tax without adding new debt, they still need other funding sources. Whether such arrangements can be implemented will continue to influence the pricing and volatility of subsequent super-long government bonds.

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