Political Uncertainty Suppresses Japanese Government Bond Demand

The Japanese bond market shows signs of weakening amid increasing uncertainty ahead of the recently scheduled parliamentary elections. According to data from Jin10, Japan’s long-term government bond auctions recorded a bid-to-cover ratio of 3.02, a significant decline from previous levels and below the 12-month average of 3.24, indicating more cautious investor interest.

Weakening Demand Amid Election Uncertainty

The declining bid-to-cover ratio reflects more conservative investor sentiment in the face of market volatility ahead of the elections. The tail spread remains stable at 0.05, the same as the previous period, but pressure on bond demand remains evident. Investors are beginning to withdraw from government debt instruments due to concerns over potential fiscal policy changes post-election, which could affect the risk profile of bonds.

The February 8 election determined the composition of the new parliament. Surveys indicate that the ruling coalition is likely to secure around 300 of the 465 seats, with the Liberal Democratic Party expected to maintain a majority. This victory would allow Prime Minister Sanae Takaichi to continue her ambitious fiscal stimulus agenda.

Fiscal Stimulus and Debt Burden Pressure

The government’s stimulus plan has serious implications for Japan’s fiscal sustainability. Last month, yields on Japanese government bonds surged to multi-year highs, especially after Takaichi proposed a consumption tax cut that would increase the government’s financial burden. Although yields later eased, the 10-year reference bond yield remains near 2.25%, the highest level since 1999, signaling persistent inflation and interest rate expectations rising.

Market Anticipates Interest Rate Hikes

Overnight index swap data indicates a 76% probability of a rate hike in April. Furthermore, the market has fully priced in the possibility of a 25 basis point increase in June. This expectation reflects investor confidence that monetary authorities will tighten policy stance to address ongoing inflation pressures.

The combination of ambitious fiscal stimulus and expectations of interest rate hikes creates a complex dynamic in the Japanese bond market, with bond demand likely to remain subdued until the market reaches a new equilibrium.