Japan's New Leader Faces Test After $41 Billion Bond Meltdown

In my last column, I explained how soaring yields for government bonds in Japan had infected other markets and spilled over into selling for U.S. treasuries.

It was a sudden shift prompted by the confirmation that Japanese Prime Minister Sanae Takaichi is calling an election for February 8.

But today? As you were!

Markets are moving back higher, with the exporter-heavy Nikkei 225 (up 1.7% on Thursday) once again near its record-high close set on January 14. The broad-market, domestic-skewed Topix (up 0.7% today) is also near its record close on January 15.

What the Short-Lived Selloff Means

I’m focusing on Japan because that’s where the selling began. But other Asian markets are moving in sympathy, with South Korea’s Kospi (up 0.9% on Thursday) setting its own record high with Thursday's close. The equally chip-driven market in Taiwan (up 1.6% on Thursday) is nearing another record.

What the moves of this week tell me is that:

1.  Markets are jumpy, looking for reasons to sell
2. Relief rallies still reward investors who buy on dips

Eventually, a selloff will prove so sustained that the bulls will concede, and start selling themselves. That, of course, is the best time to buy, just when no one wants to.

We’re nowhere near that point.

Record High for Long-Term Yields

Tuesday’s short-lived meltdown came as the yield on the relatively new 40-year Japanese Government Bond (JGB) crested to 4.22%, a record since its introduction in 2007. The 30-year JGB backed off at 3.88%, still a record since it was unveiled in 1999.

I was wrong that JGBs had never seen such levels before, since the short-term, 10-year JGB shot as high as 8.0% back in September 1990, as Japan’s asset bubble was bursting. Thanks reader @DanP for pointing that out.

Takaichi, on Monday, confirmed she is calling an election, which in Japan must occur after just two weeks of campaigning.

It should ultimately be positive for markets if Takaichi cements her position as prime minister, as seems likely. She supports high levels of government spending, and low interest rates, both of which should be positive for stocks in particular. And her personal popularity is proving far higher, the latest rating at 78.1%, well ahead of the paltry 29.7% support for her Liberal Democratic Party.

But on Tuesday, there was a spate of selling indicating concern about how she would pay for her campaign promises to suspend an unpopular sales tax on food for two years, and find other ways to support affordability for Japanese households.

Iron Lady or Liz Truss Lettuce?

Japan’s first female leader likes to liken herself to the “Iron Lady,” Britain’s Margaret Thatcher. But there was plenty of commentary on Tuesday comparing her instead to Britain’s second female prime minister, Liz Truss, who had the shortest spell in the power seat thanks to what a Reuters columnist dubbed “an entirely self-made trap” of debt-fueled growth and tax cuts.

I expect Takaichi, relatively charismatic and colorful in contrast to her three predecessors, to be closer to Thatcher in her influence. And she’s already spent 93 days at Japan’s helm to more than match the 49 days that Truss lasted in 2022. Truss famously lasted less time than it took for a lettuce to wilt in a livestream.

Still, there’s no doubt that a temporary break on the 8% consumption tax on food will be hard to pay for, and even harder to walk back. Japan’s public debt-to-GDP ratio, around 230%, is the highest among major economies, with almost 60% of Japan’s budget spent to service public debt and on social security.

But Takaichi has a good read on what will appeal to voters, hence her crowd-pleasing policies. She refuses to walk back her cut to the consumption tax, something her economic-policy mentor Shinzo Abe delayed but was forced to raise in 2019. A 10% consumption tax on goods outside of food will remain in place.

Walking Wages and Prices Higher 

Japan spent the better part of three decades in a deflationary spiral that was deadly for its economic prospects. But Abe managed to reflate the economy and restore confidence in Japanese companies and consumers.

Inflation has stayed above the central-bank target of 2.0% since April 2022. Soaring prices for staples such as rice, which in December hit a record high of ¥4,335 ($27) per 5 kg (11 lb) bag, prompted consumer anger that translated to a terrible showing for the ruling Liberal Democratic Party in elections last year.

I was in Okinawa last July, and flagged these concerns just ahead of the elections that saw the LDP lose its majority in the Lower House of Japan’s parliament, known as the Diet.

There’s a contradiction that Takaichi wants to tackle inflation by revisiting Abe’s inflationary policies. She clearly understands what will appeal to the public, however, with studies showing that, globally, citizens attribute wage gains to their own hard work but blame outside influences for inflation that causes the cost of goods to rise.

Bond Meltdown Came on Very Thin Trade

A coda to the quickly forgotten bond-market shock from Tuesday:

The $41 billion wipeout in JGBs was prompted by just $280 million in trading, according to Japan Bond Trading Co. numbers as crunched by Bloomberg.

How can that be?

The central Bank of Japan (BOJ) has dominated the buying of JGBs in a bid to prop markets, leaving it holding some 53% of all issuance at last count. But it began tapering its purchases in 2024, leaving the JGB with a lack of liquidity.

That’s particularly true for the unusually long-term 40-year bond. Only $110 million changed hands on Tuesday, with anther $170 million in the 30-year JGB. They were the worst-hit, on pretty thin trade.

That weakness didn’t last. Takaichi is cementing her position with savvy geopolitical moves, sweet-talking world leaders, recently meeting U.S. President Donald Trump, South Korea’s Lee Jae-myung and Italy’s Giorgia Meloni for summit-level talks while standing up to China on Taiwan.

We will see how that translates to the polls on February 8. But I expect voters to deliver her a stronger mandate to continue Abe’s political legacy, which provided an extremely strong base for Tokyo stocks. Just as with U.S. treasuries, there’s such a strong base of institutional investors (not least the BOJ) holding Japanese government issuance that the bond market can ride out all but a total freezing up of financial markets.