By Kevin Buckland and Rocky Swift
TOKYO (Reuters) -Japanese government bond investors are bracing for a potential power shift in upper house elections this weekend that could end up worsening the country’s already frail finances.
Prime Minister Shigeru Ishiba’s sliding popularity has analysts and investors questioning whether even his modest goal of retaining a majority is achievable.
Defeat could bring anything from a shift in the composition of the coalition to Ishiba’s resignation, though even the least disruptive scenario is still expected to see more stimulus-minded political viewpoints gain sway.
“As the noise towards yet more fiscal spending picks up, we have increased our underweight in Japan as a whole,” said Ales Koutny, head of international rates at Vanguard.
“Japan is going down a similar path as the UK did a couple of years ago,” Koutny said. “If no fiscal restraint, then the bond market will start to put pressure on the economy.”
Japan’s debt burden is the highest in the developed world at about 250% of GDP.
Concerns about promises of fiscal largesse from opposition parties backing tax cuts were instrumental in sending yields on Japan’s longest-dated government bonds (JGBs) surging to record peaks in late May.
The Ministry of Finance was able to restore some calm to the market with plans to reduce issuance of 20-, 30- and 40-year bonds to address a supply-demand imbalance for those tenors, with traditional demand from life insurers dropping sharply this year.
The Bank of Japan’s reticence to raise interest rates further against an uncertain global economic backdrop is also keeping investors sidelined.
“If such a demand-less market continues and investors foresee no rate hikes within this fiscal year, JGB volatility will go up, especially in the long end,” said Kentaro Hatono, a fund manager at Asset Management One, who says he’s adopting a “wait-and-see” stance due to the risks of the yield curve steepening after the election outcome.
The persistent fragility of the so-called super-long sector has been on display for the past week, as opinion polls showed a sharp drop in Ishiba’s approval ratings.
Benchmark 30-year JGB yields vaulted 13 basis points to 3.17% on Monday, bringing them just shy of the all-time high of 3.185% from May 21. A week earlier, those same yields had surged as much as 22.5 basis points over two days to 3.09% on July 8.
Barclays calculates that the rise in 30-year yields currently factors in about a three percentage-point cut to Japan’s 10% consumption tax rate.
“Even if the ruling parties retain their majority in the upper house, they would still be unable to pass budget bills, including the upcoming supplementary budget, without the cooperation of the opposition parties,” the bank’s Japan-based analysts wrote in a research note.
“In this context, we believe there will likely be a convergence toward an expansionary budget proposal.”
All three of the leading opposition parties espouse some form of consumption tax cuts, with the populist, right-wing Sanseito party proposing a phasing out of VAT altogether.
The policy has gained sway with the public as well: a recent poll by the Asahi newspaper showed 68% of voters thought a sales tax cut was the best way to cushion the blow from rising living costs.
Fiscally hawkish Ishiba has eschewed that option in favour of cash handouts.
A poor election result for the ruling coalition will trigger a sell-off in super-long JGBs by so-called real money investors, including life insurers and institutional investors, predicts Toshinobu Chiba, a fund manager at Simplex Asset Management.
“If the opposition parties win, the government deficit will see a huge expansion,” Chiba said. “The JGB yield curve will steepen by a lot.”
(Reporting by Kevin Buckland and Rocky SwiftEditing by Shri Navaratnam)
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