As Japan's general election approaches, concerns about the collapse of fiscal discipline are rapidly spreading in the Japanese bond market. Investors are showing extreme vigilance in the face of potential massive tax-cut commitments without funding.
According to Xinhua News Agency, Japanese Prime Minister Takahashi Sanae stated at a press conference on the 19th that she would dissolve the House of Representatives on January 23 and hold a general election on February 8. Takahashi Sanae said that she will start preparing to cancel the consumption tax on food for two years, with the issue of funding for the consumption tax reduction still under consideration. There may be cuts in subsidies, and the overall budget will be revised. She will ensure the sustainability of Japan's fiscal situation by reducing the ratio of Japan's debt to GDP.
Analysts believe that if the policy of abolishing the consumption tax on food for two years is implemented, it is expected to result in an annual tax cut of about 5 trillion yen. However, what unsettles the market is that the Japanese government has not yet disclosed specific sources of funding to fill this huge fiscal gap.
As a result, the Japanese government bond market is facing severe selling pressure. On Tuesday, the panic over fiscal expansion combined with weak demand in the auction of 20-year government bonds led to a historic sell-off in Japanese government bonds, with the yield on 30-year government bonds rising 26.5 basis points to 3.875%; the yield on 40-year government bonds rose 27 basis points to 4.215%, setting a new historical high.
Market participants generally worry that if Takahashi Sanae cannot provide specific financing plans other than relying on "economic growth," investors will have to reprice Japan's sovereign risk. Naka Matsuzawa, chief interest rate strategist at Nomura Securities, warned that Japanese long-term and ultra-long-term government bonds are likely to experience significant volatility around "speculation about the reduction of food consumption tax" and "sources of funding for tax cuts."
5 Trillion Yen Gap and "Ambiguous" Funding Sources
According to Nomura's analysis, the tax-cut proposal currently being weighed by the ruling party has clear electoral strategic intentions. The Liberal Democratic Party considers this policy partly to align with the Japan Innovation Party, which has also proposed similar measures, and also to counter the centrist reform alliance calling for similar tax cuts.
However, the cost of this strategy for the bond market is expensive. Suspending the consumption tax on food for two years means a loss of approximately 5 trillion yen in annual fiscal revenue.
Naka Matsuzawa warned in her report that the Takahashi government might claim that the expenditure will be funded by unexpected tax revenues generated through economic growth, but this is unlikely to be accepted by market participants who are already worried. In the absence of clear plans for tax increases or spending cuts, this "unfunded" fiscal expansion directly undermines investors' confidence in the sustainability of Japan's fiscal situation.
No One Wants to Catch a Falling Knife
Under the context of questionable fiscal discipline, the long-end yield curve of Japanese government bonds is becoming exceptionally fragile.
Nomura expects that due to the weakness in the U.S. and European bond markets and the negative impact of Japan's domestic tax-cut proposal, the Japanese bond market will continue to decline. Although the strength of the yen and the safe-haven sentiment from the United States may provide some support, long-term and ultra-long-term Japanese bonds will be the first to suffer, serving as an outlet for the market's concerns about deteriorating fiscal conditions.
At the same time, the market's expectations for the Bank of Japan (BOJ) to normalize its policies have not faded. Currently, the market pricing indicates that the probability of the BOJ raising interest rates in April has risen to 61%. Although Naka Matsuzawa believes that the conditions for forming a market consensus (probability exceeding 70%) are not fully met, under the dual pressures of interest rate hikes and fiscal deterioration, the valuation pressure faced by Japanese government bond holders is intensifying.
MASAHIKO LOO, senior fixed income strategist at State Street Investment Management, commented:
"The 'Takahashi trade' remains very active. The simplest trading method is to short the yen, short Japanese government bonds or raise yields, and then go long on the Nikkei index.
Japan's herd mentality is very severe. This is why all banks are not buying bonds. Why aren't they buying? Because they are all waiting for the Bank of Japan to raise interest rates.
No one wants to catch a falling knife."
Policy Directions Under the Election Game
Market analysts generally believe that Takahashi Sanae's decision to dissolve the House of Representatives and hold a general election at this time is more of a political tactic, aiming to seek re-election at the most favorable moment, rather than representing a fundamental shift in economic policy.
Nomura's report pointed out that Takahashi Sanae may continue to use the vague phrase "responsible, proactive fiscal policy" to calm various parties. For investors, the key observation window is her press conference tonight: will she formally include the food tax reduction as a campaign promise, and will she detail the funding sources? If the government only emphasizes national security issues or seeks to change the authority of its ruling coalition partners, while being vague about fiscal details, the market's anxiety about Japan's fiscal prospects is unlikely to ease.
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Original: toutiao.com/article/7597383750934118938/
Statement: The article represents the personal views of the author.