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Yields on 10-year Japanese government debt have hit their highest level since the 2008 financial crisis as markets begin to price in the risk of populist campaign pledges and political uncertainty ahead of an election.
The 10-year yield, which moves inversely to prices, rose 1.5 basis points on Tuesday to 1.59 per cent as an increasing number of polls suggested the ruling Liberal Democratic party would suffer heavy losses in Sunday’s upper-house parliamentary elections.
“The market sold off on the expectation the LDP is going to lose its majority in the upper house,” said Wei Li, head of multi-asset investment at BNP Paribas in China.
Traders are increasingly concerned that Sunday’s vote could force the LDP to make concessions to smaller parties whose popularity has been built on pledges that would strain the finances of a country with the developed world’s highest level of public indebtedness.
The LDP, which has been the ruling party for most of Japan’s postwar history, lost outright control of the lower house in October, forcing them into uncomfortable co-operation with smaller parties.
A loss of its upper-house majority could trigger a range of possible scenarios, said analysts, including a coalition that hands influence to populist minority parties, the ousting of Prime Minister Shigeru Ishiba or a snap general election that brings about a full change of government.
In the run-up to Sunday’s election, voters have expressed dissatisfaction with rising inflation, low wage growth and high taxes, leading to a wave of support for previously marginal parties that have pledged more spending, cash handouts and cuts to the consumption tax. The LDP has also promised cash handouts and measures to lower energy prices.
The average estimated cost of each party’s proposals would be ¥5.3tn ($36bn) when weighted by their presence and presumed influence over the upper- and lower-house budget committees, according to Morgan Stanley rates strategist Koichi Sugisaki.
The concerns around Sunday’s election play into deeper fears about the stability of Japan’s longer-maturity government debt market, said rates analysts.
In May, 30-year yields lurched higher after a series of unexpectedly disappointing auctions of 20-, 30- and 40-year debt.
The auctions highlighted what many strategists believe is a chronic supply-demand imbalance after Japan’s life insurers and banks shifted their strategies towards shorter-term debt.
While the finance ministry has sought to calm markets by reducing issuance of super-long debt, demand has remained lacklustre. The 30-year yield rose 4 basis points on Tuesday to an all-time high of 3.205 per cent.
“Investors remain very much concerned about the risks to Japanese fiscal discipline against a backdrop of structurally slack supply-demand,” said Sugisaki.
Mark Dowding, chief investment officer for fixed income at RBC BlueBay Asset Management, said the steepness of Japan’s government bond yield curve was “largely” a function of the government selling too much super-long debt. “Issuing too many bonds that the market does not want is a policy error,” he said.
At the same time, analysts note that Japan’s fiscal situation has improved with rising tax revenues due to inflation. “Japan’s fiscal metrics are in the best shape they’ve been in decades,” said Stefan Angrick, head of Japan economics at Moody’s Analytics.
The most recent poll from state broadcaster NHK shows 24 per cent support the LDP and 7.8 per cent back the main opposition Constitutional Democratic party of Japan.
The rest went to minority parties, including 5.9 per cent for the openly xenophobic Sanseito party, whose campaign has fed heavily on the ruling bloc’s traditional voters.
Additional reporting by Ian Smith in London