The market temporarily eases fiscal concerns as Japan's ultra-long-term government bonds continue to rebound

Japan’s ultra-long-term government bonds continue to strengthen after the election, with Sanae Takaichi’s cautious stance on reducing the food consumption tax easing investors’ concerns about fiscal policy and driving yields further lower.

According to Bloomberg, the 40-year Japanese government bond yield fell by 10 basis points, and the 30-year yield declined by 9.5 basis points, returning to levels seen in early January, continuing the post-election rebound.

The key market reaction hinges on Sanae Takaichi’s latest comments. In her first press conference after winning, she mentioned market concerns over the two-year reduction plan for the food consumption tax and discussed goals to increase spending on national defense and strategic industries. However, she did not make strong commitments to lowering the food consumption tax, easing concerns in the bond market about fiscal sustainability.

Meanwhile, the yen has strengthened against the dollar for three consecutive trading days this week, but Japan’s top foreign exchange official, Atsushi Mimura, stated on Thursday that the government remains vigilant. While investor sentiment has improved, the market is still assessing how a funding gap would be “sustainably” filled if tax cuts are pursued without issuing additional bonds.

Ultra-long yields decline, post-election rebound continues

In recent weeks, concerns over fiscal sustainability have caused sharp fluctuations in ultra-long government bonds. Bloomberg reports that as yields have fallen back to levels seen in early January—when Sanae Takaichi’s surprise election victory was first reported—market pricing of “tail risks” has converged.

This downward movement has been concentrated at the long end, with the rapid decline in 30-year and 40-year yields, reflecting a reallocation of funds toward longer maturities that are more sensitive to fiscal expectations.

More restrained policy signals, postponement of debt and tax cut concerns

Bloomberg notes that one interpretation of Takaichi’s victory in the bond market is that the political outcome could lead to clearer policy pathways, thereby reducing the likelihood of extreme fiscal measures.

In terms of her statements, Takaichi acknowledged market concerns over the food consumption tax cut but also emphasized that the Ministry of Finance will not fill spending gaps by issuing new debt, instead reviewing subsidies, special taxes, and non-tax revenues to find what she calls “sustainable” funding sources.

Her lack of a strong commitment to lowering the food consumption tax is also seen as a signal to temporarily ease pressure on new supply.

Institutional views: high yields attract short covering, rate declines may continue

Ryutaro Kimura, senior fixed income strategist at AXA Investment Managers Ltd., said that Takaichi’s failure to make a firm promise on lowering the food consumption tax gives bond investors “a strong motivation to restore ultra-long Japanese government bond long positions.”

These bonds previously offered “historically high yields.” He also stated that the downward trend in ultra-long rates “may continue for some time.”

This view aligns with market trends, suggesting that as policy uncertainty marginally eases, funds are more willing to re-enter long positions that had shrunk due to volatility.

Tail risks remain: if tax cuts are pushed forward, how will the funding gap be filled?

Despite improved market sentiment, Bloomberg points out that investors remain cautious about the possibility of sharp market fluctuations reemerging.

The reason is that even if the government does not issue additional bonds to fill the gap, reducing the sales tax without new debt may still require other funding sources. Whether these arrangements can be realized will influence the pricing and volatility of ultra-long government bonds going forward.

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