Sanae Takaichi personally opened the "Pandora's box." Can central bank intervention prevent the collapse of Japanese bonds?

What the Japanese government bond market is experiencing is not an ordinary interest rate rise, but a crisis of confidence triggered by politics, amplified by fiscal policy, and ultimately falling on the central bank.

After Prime Minister Sanae Takaichi proposed a reduction in the consumption tax on food items, the market responded in the most direct way: selling off government bonds, selling yen, and simultaneously depressing stock market valuations. In just two trading days, Japan's 10-year government bond yield rose by about 15 basis points, and the 30-year yield soared 30 basis points at one point—a level of volatility extremely rare in history.

According to Chasing Wind Trading Desk, JPMorgan directly stated that this policy is “like opening the Pandora’s box of Japanese fiscal policy”; Nomura went even further, warning that the Japanese bond market is facing a risk similar to the UK's “Truss shock”—the “Takaichi shock”.

The key issue is not how much this tax cut "costs," but—it shakes the market’s trust in the last line of defense of Japan’s fiscal discipline.

Electoral politics stack with fiscal commitments, risk is priced in all at once

According to Xinhua News Agency, Sanae Takaichi has announced plans to dissolve the lower house on January 23 and hold a general election on February 8. During this highly sensitive political window, she made it clear in her campaign activities that she hopes to abolish consumption taxes on food and beverages within two years, admitting that this goal faces “very high obstacles,” but she will continue to push for related discussions.

This statement quickly triggered a chain reaction. Major political parties joined the discussion on consumption tax reductions, with the Centrist Reform Alliance even proposing to use the government pension investment fund (GPIF) or government assets to cover the fiscal gap. Even within the Liberal Democratic Party, it is believed there may be considerations to use foreign exchange or special pension accounts.

But for the bond market, these schemes are hardly considered “qualified sources of funding.”

Nomura and JPMorgan Consensus: This is an “election-driven fiscal shock”

Nomura estimates that even if the tax reduction lasts only two years, suspending the food consumption tax would still cause annual tax revenue losses of about 5 trillion yen for central and local governments. The magnitude itself may not be enough to immediately trigger a debt crisis, but the message it sends is extremely dangerous.

Investors are especially wary because some political parties have proposed covering the gap with the government pension investment fund (GPIF), foreign exchange reserves, or other government assets. JPMorgan clearly pointed out that these methods, in the view of the government bond market, do not constitute “real fiscal funding sources,” and may further blur fiscal boundaries.

JPMorgan notes that the market is not concerned about a one-off fiscal stimulus, but rather, worries that the consumption tax—a tool long seen as Japan’s “last bastion” of fiscal discipline—is being used for political purposes.

Why is the “Pandora’s box” more dangerous than the balance sheet?

JPMorgan described this tax cut as a “Pandora’s box,” not because of its short-term costs, but because it triggers four deep-seated concerns:

First, the credibility of restoring tax rates is thoroughly questioned. Many market participants believe that once the food consumption tax drops to 0%, it will be nearly impossible, politically, to restore it to 8% in two years. The promise that the cut is “temporary” lacks credible constraints.

Second, the policy lacks growth attributes. This tax cut is not regarded as a measure to boost productivity, encourage technological investment, or improve potential growth, but more as a short-term concession under the banner of easing the burden on people's livelihoods.

Third, the last line of fiscal discipline has been breached. The consumption tax has long been regarded as Japan’s “last bastion” of fiscal discipline. Once this tool is politicized, the market will reevaluate the credibility of all fiscal commitments.

Fourth, sovereign rating risk is re-entering the pricing model. Ratings agencies’ tolerance for Japanese fiscal policy is built on “policy predictability.” Once that premise is weakened, the risk of a ratings outlook downgrade will persist.

Investor behavior starts “de-Japanizing”

From a trading structure perspective, this round of turmoil is not just an emotional outburst, but a systematic adjustment in the flow of funds.

JPMorgan points out that the main marginal buyers of ultra-long Japanese government bonds are concentrated among overseas investors and the pension system. But in the current environment:

Overseas investors may be forced to close out yield curve flattening trades;Pension funds, with the stalled equity market rally, have less willingness to reallocate into bonds;Regional banks, under pressure from the Financial Services Agency to inspect unrealized losses in their government bond holdings, are passively adjusting their positions;Life insurers, faced with rising rates and shortening liability duration, are speeding up ultra-long bond sales.

The result is a structural vacuum in demand for ultra-long government bonds.

More worryingly, the recent yield increases are not confined to the 30-year or 40-year tenor. The rise in risk premium has started to spread to medium-term maturity, indicating that the market’s concerns are about the overall fiscal path, not just a supply-demand imbalance in a single tenor.

“Takaichi shock”: a more challenging situation than 2025

Nomura strategist Nakaka Matsuzawa points out that, unlike the ultra-long government bond turbulence in spring 2025, which was mainly about supply-demand structure, the current sell-off arises from a crisis of confidence in policy direction.

In the latest round of trading, there appeared a very unusual combination: ultra-long yields soared while stocks and the yen weakened simultaneously.

This means investors are lowering allocations to Japanese assets across the board, rather than simply adjusting the duration structure.

Matsuzawa warns that if the Bank of Japan intervenes rashly, it may trigger concerns about “policy lag,” causing the yield curve to steepen further, and, via yen depreciation, reverse reinforce inflation expectations, creating a vicious cycle.

Central Bank and Ministry of Finance: Intervention space greatly narrowed

Operationally, the Bank of Japan is not without tools:

In the short term, it can temporarily expand government bond purchases, Ministry of Finance can buy back ultra-long bonds, or reduce auction size;

In the medium term, it can slow quantitative tightening (QT), revise issuance plans, or normalize buyback operations.

But the problem is—when the market is doubting fiscal direction itself, the central bank’s technical intervention may backfire.

As JPMorgan said, once the “Pandora’s box” is opened, it is difficult for the market to restore trust on its own. The fundamental solution remains to withdraw or explicitly limit the consumption tax reduction proposal and provide a credible explanation of the fiscal path.

Conclusion: This is a crisis of confidence, not a liquidity crisis

The current turmoil in Japan’s government bond market is, in essence, not due to runaway inflation or disorderly interest rates, but a fiscal crisis of confidence driven by politics.

Takaichi’s tax cut statement may make sense electorally, but in the eyes of the bond market, it touches on a deeper issue: Is Japan still willing to pay a political price for fiscal discipline?

Before this question is clearly answered, the central bank’s intervention can, at most, delay the adjustment, but cannot stop the market from repricing.

Risk Warning and DisclaimerMarkets carry risks, investment requires caution. This article does not constitute personal investment advice, nor does it take into account individual users’ specific investment objectives, financial circumstances, or needs. Users should consider whether any opinions, views, or conclusions in this article suit their circumstances. Investment is at your own risk.