(Bloomberg) — The slump in Japan’s long-term bonds intensified Monday, pushing yields sharply higher in a move that puts global debt markets on alert.
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Amid signs of thin liquidity and increasing worries about higher government spending in Japan, yields on bonds from the 10-year to the 40-year spiked in moves reminiscent of the surge that rippled through global markets in May.
While the pressure in Japan is being heightened by the looming election on July 20, concerns over governments spending beyond their means also apply to the UK, Europe and US.
Japan’s 40-year yield led the way, with a jump of 17 basis points in afternoon trading, while the 30-year yield neared the record high seen in May and the 20-year yield touched the highest since 2000.
The rout in Japan’s debt market also followed a tumble in US Treasuries on Friday as worries about inflation re-emerged. In Germany on Monday, long-term borrowing costs were on course to hit their highest since 2011 amid concern over tariffs and extra government spending.
“Government spending is huge,“ said Amir Anvarzadeh, Japan equity strategist at Asymmetric Advisors Pte. “Inflation is up, wages are up. At some point something has to give,” he said, adding that rising JGB yields are also a worry for stocks.
Focus has intensified on the nation’s upper house election, with several local Japanese media polls pointing to the possibility the ruling bloc may lose its majority. Politicians have been wooing voters with promises of more government spending and tax cuts, which would increase the nation’s debt load.
“There is a move to reduce risk ahead of the upper house election in the bond market,” said Miki Den, senior rates strategist at SMBC Nikko Securities. “With few buyers expected before the election and ongoing selling flows, super-long-term bonds are experiencing large price fluctuations and are being sold off.”
What Bloomberg Strategists say:
“Long-ended JGBs are selling off nastily yet again toward the end of Tokyo’s day and that’s casting a shadow on Europe’s morning by reemphasizing concerns that bond markets are fragile heading into critical US inflation data later this week”
— Garfield Reynolds, MLIV Team Leader, Sydney.
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Yields also rose in response to a report from Bloomberg that Bank of Japan officials are likely to consider raising at least one of their inflation forecasts at a policy meeting later this month.
“The fiscal concerns will continue to keep super-long bonds quite fragile,” said Shinichiro Kadota, head of Japan FX and rates strategy at Barclays Securities Japan Ltd.
A surge in domestic interest rates also poses a potential headwind for Japan’s corporate bond market, which saw record volume in the first quarter of the new fiscal year through June.
Higher yields translate directly into increased debt issuance costs for companies, raising concern that they may scale back yen bond offerings. This could also accelerate a shift toward offshore funding.
In the sovereign debt market, a lack of liquidity in recent months has made bonds particularly vulnerable to sharp swings. A Bloomberg gauge that examines how far intraday yield levels deviate from fair value has surged since early April and is now well above the previous peak set during the global financial crisis in 2008.
“The sharp rise in super-long yields show that the market is pricing in government fiscal risks to some degree,” said Yuichi Kodama, economist at Meiji Yasuda Research Institute. “But the impact on the real economy has not yet materialized.”
Kodama emphasized that what’s more important is 10-year bond yields, which are linked to fixed mortgage rates and would have a significant impact on the real economy. The 10-year yield rose to 1.575%.
Bank of Japan Governor Kazuo Ueda has said the nation’s super-long yields — which are generally thought of as those on the 20-year maturity and higher — have limited impacts on the real economy compared to shorter-term debt. Yet he has also said the will carefully monitor developments.
“Ueda is currently downplaying the spike in super-long yields, but I’m sure he’s watching the situation closely,” Kodama said. “He’s avoiding explicit comments because any statement could be interpreted as signaling market intervention or as a threshold for intervention.”
Atsushi Takeda, chief economist at Itochu Research Institute, said that businesses broadly don’t take on debt in the super-long end, meaning it has limited importance for the real economy.
“But we are starting to see a rise in 10-year bond yields due to concerns over fiscal health and that’s something we must keep a close eye on,” Takeda said. While the result of the upper house election is hard to predict, “opposition parties are calling for a cut in the sales tax so if they win, fiscal anxiety will stay. If Ishiba’s LDP wins, investors are probably back to buying bonds.”
This year Japan allocated about a quarter of its initial budget to debt-servicing costs, totaling ¥28.2 trillion ($191 billion). The country has a debt-to-GDP ratio of 250% according to the IMF, the largest among developed economies.
If the ruling parties take a beating in the upcoming election, Japan could be pushed into further fiscal spending or tax cuts. Opposition parties have lobbied for a decrease in the sales tax to varying degrees, while the ruling Liberal Democratic Party has proposed cash handouts that take less of a toll on public finances.
“These crazy moves probably can’t be helped until the election is over,” said Tsutomu Soma, a bond and currency trader at Monex Inc. who is a 40-year trading veteran. “I’ve never seen Japan’s bonds move like this before an election. Usually you just think about it after the election’s done.”
–With assistance from Mia Glass, Alice French, Masahiro Hidaka, Issei Hazama, Yoshiaki Nohara and Toru Fujioka.
(Updates with more quotes, economic context and implications for corporate debt market.)
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