The yield on benchmark 10-year Japanese government bonds hit the 3% threshold on Tuesday for the first time in three decades. Behind the surge was mounting market wariness over the administration of Prime Minister Sanae Takaichi's fiscal expansion, as well as speculation that the Bank of Japan will accelerate the pace of its interest rate hikes.
Surging yields will drive up debt-servicing costs and narrow policy options in budget planning, casting doubt on whether the administration can maintain its aggressive spending strategy.
Warning over outlook
Bond dealers worked frantically at their screens on Tuesday afternoon at Mitsubishi UFJ Morgan Stanley Securities Co. in Chiyoda Ward, Tokyo.
"If concerns over Japan's worsening fiscal health escalate, yields could climb well past the 3% mark," warned Takahiro Otsuka, a senior fixed-income strategist at the firm.
The rising yields were spurred by deep-rooted market wariness over the Takaichi administration's expansionary fiscal stance.
The yield on Japan's benchmark 10-year government bonds fell to an all-time low in the minus 0.3% range in 2016, when the BOJ introduced its negative interest rate policy. It shifted to an upward trend after the central bank ended its negative interest rate policy, and the pace of the increase has accelerated since the launch of the current administration in October last year.
When Takaichi took office, the yield was around 1.65%. It quickly climbed past 2% in mid-December under the combined pressure of an additional BOJ rate hike and the drafting of the fiscal 2026 budget, ultimately rising by about 1.4 percentage points in less than a year.
Takaichi abandoned the goal of achieving a single-year primary balance surplus, a target pursued by successive administrations, and shifted focus toward steadily lowering the ratio of outstanding government debt to gross domestic product.
However, many observers, including market insiders, have said this will not lead to fiscal consolidation.
A consumption tax cut on food set for next April will result in an annual revenue loss of 4.3 trillion yen. Takaichi intends to secure alternative financial sources without relying on deficit-covering bonds, but securing alternative funds is expected to be a daunting challenge.
With the deadline closing on Monday, general-account budget requests for fiscal 2027 are expected to total approximately 143 trillion yen.
A rush of budget requests under an investment bracket with no ceiling is expected to push the total up by around 20 trillion yen from the initial budget for fiscal 2026.
Takaichi has indicated plans to cap the issuance of new government bonds in fiscal 2027 at around 40 trillion yen, but the move has done little to stem rising interest rates.
Impact on growth strategy
Rising bond yields inflate debt-servicing costs on government bonds, making fiscal management all the more difficult.
In the budget requests for fiscal 2027, debt-servicing costs, which include bond redemptions, stood at 36.63 trillion yen. The figure surpassed the 33.68 trillion yen requested by the Health, Labor and Welfare Ministry for social security programs such as pensions and medical care.
Debt-servicing costs in the initial budget for fiscal 2026 were 31.27 trillion yen.
To prepare for sudden spikes in yields, the government set the assumed interest rate for calculating debt-servicing costs at 3.8%, adding roughly 1 percentage point to the average of actual market yields over the past three months.
With the assumed interest rate set to be revised based on prevailing market yields during year-end budget compilation, any continued climb in yields would further inflate debt-servicing costs.
"If long-term rates climb excessively, it could curb corporate capital spending and potentially affect the growth strategy championed by the Takaichi administration," said Koki Akimoto, an economist at the Daiwa Institute of Research Ltd.
Inflation concerns
With no end in sight to tensions in the Middle East, long-term interest rates are on an upward trend globally, fueled by fears that prolonged fighting will keep crude oil futures elevated and prolong inflation.
The yield on the benchmark 10-year U.S. Treasury note rose to around 4.75% on Monday, its highest level in about 19 months.
As Federal Reserve Board Chairman Kevin Warsh hinted at future rate hikes during a speech on Friday, speculation grew that the Fed could raise interest rates as early as September.
Reflecting this trend, selling pressure has also intensified on Japanese government bonds, leaving the BOJ facing difficult choices over future interest rate hikes.
Based on trading activity among market participants, Totan Research Co. estimated that the probability of the central bank hiking its policy rate from 1% to 1.25% at its Sept. 17-18 policy meeting topped 90% as of Tuesday afternoon, effectively cementing expectations for a rate increase.
Another rate hike is expected by next January to bring the policy rate to around 1.5%, fueling market speculation that the BOJ is accelerating the pace of its interest rate increases.
As expectations of rate hikes mount, investors become reluctant to buy current government bonds carrying lower yields, which in turn exerts further upward pressure on long-term rates.
Future policy management will focus on how to strike a balance between containing inflation and mitigating the side effects of rising interest rates.
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This article is from The Yomiuri Shimbun. Neither Dow Jones Newswires, MarketWatch, Barron's nor The Wall Street Journal were involved in the creation of this content.
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