Japanese government bonds are facing an epic sell-off, with long-term bond yields surging to record levels, mainly due to market investors' panic over Prime Minister Takahashi Hayato's aggressive fiscal expansion plan and the inflation risks it has triggered.

On the 20th, the yield on Japan's 30-year government bonds rose by 26.5 basis points to 3.875%; the yield on Japan's 40-year government bonds increased by 27 basis points to 4.215%, setting a new historical high. The trigger for this sell-off was the government's promise to cut food consumption tax to win the election, but without specifying the source of funding, which has sharply increased market concerns about Japan's fiscal discipline and government spending.

This bond market crash has already begun to affect stock and foreign exchange markets, putting immense pressure on the Bank of Japan. Analysts point out that in order to prevent yields from getting out of control, the Bank of Japan may be forced to accelerate its interest rate hikes, or even need to immediately launch emergency bond purchasing operations to calm the market.

Strategists have warned that the current market turbulence is similar to the UK's "Truss shock." If authorities do not soon send clear interest rate signals or intervene, volatility may worsen further, potentially spreading to the global bond market.

The "Truss Moment" Reemerges?

The core of this market turmoil lies in the fear of "unfunded fiscal stimulus." Rinto Maruyama, an FX and interest rate strategist at SMBC Nikko Securities Inc., pointed out that Takahashi Hayato appeared very radical in his press conference and proposed a consumption tax reduction plan without a clear source of funding. He called this a "major shock," as the market currently cannot see how the government plans to fund the proposed tax cuts. Although Japan's credit default swaps (CDS) have not risen as much as during the UK's "Truss shock," interest rates still surged due to the lack of a clear funding source.

Katsutoshi Inadome, a senior strategist at Sumitomo Mitsui Trust Asset Management Co., said the bond market was "confused and surprised" by this announcement, leading to an uncontrolled rise in interest rates. Shinji Kunibe, a global fixed-income portfolio manager at Sumitomo Mitsui DS Asset Management Co., described the market's panic:

"After the originally seemingly routine 20-year government bond auction quickly turned into a crash, everyone was glued to their screens. It looked like a warning from the market about fiscal expansion."

Wall Street Calls for Central Bank "Emergency Rescue"

Faced with continued selling, Wall Street analysts believe the Bank of Japan's intervention is imminent. Gareth Berry, a strategist at Macquarie Bank in Singapore, said that if the plunge intensifies, the Bank of Japan might intervene and purchase Japanese government bonds. He pointed out that although Governor Haruhiko Kuroda has been reluctant to use this tool, he may soon have no choice. "If the selling continues, especially if it spreads globally, we should see the Bank of Japan reactivating this tool, possibly even implementing it as early as the daily operations tomorrow morning."

Tadashi Matsukawa, head of bond investments at PineBridge Investments Japan Co., also believes that as interest rates have risen so significantly, calls for the Bank of Japan to conduct emergency operations and for the Ministry of Finance to implement buybacks may intensify. He pointed out that although the issuance volume of ultra-long-term bonds decreased last year, the supply and demand situation has not improved.

Challenges in Monetary Policy Normalization

It is widely believed that the current fiscal situation makes the Bank of Japan's monetary policy too loose. Simon Ballard, chief economist at First Abu Dhabi Bank, pointed out that the market is punishing the current policy mix, forcing investors to turn to stocks. He believes that the Bank of Japan's policies are too loose compared to nominal growth and fiscal deficits. Ballard emphasized that with an inflation rate of 3% and wage growth of 5%, plus Takahashi Hayato's supplementary budget and expectations of additional fiscal deficits in 2026, the current market pricing (two rate hikes) is far from sufficient; in fact, four rate hikes are needed.

Prashant Newnaha, a senior Asia-Pacific interest rate strategist at TD Securities, stated that every Japanese government has underestimated the interest rate increases and yen depreciation risks brought by expansionary policies. The market is beginning to price this through higher neutral rates and term premiums, which also explains why there are few buyers in the Japanese government bond market. He warned that expansionary fiscal policy means rising yields will be persistent, and the yield on 40-year Japanese government bonds could break above 4% in the coming months.

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Original: toutiao.com/article/7597366753383744006/

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