By Kevin Buckland
TOKYO (Reuters) -Japan’s bond market faces stern tests this week, from domestic political ructions and a possible hawkish shift at the central bank to global risks stemming from the Federal Reserve.
Japan’s long-dated government bond (JGB) yields remain near record peaks after the ruling coalition lost its majority in upper house elections. Opposition parties advocating debt-funded tax cuts have strengthened, adding pressure on fiscally conservative Prime Minister Shigeru Ishiba to step aside.
Meanwhile, short-dated JGB yields rose to multi-month highs following a trade deal with the United States, which removes an obstacle for the Bank of Japan (BOJ) to resume interest rate hikes.
POLITICAL TURMOIL
Ishiba’s resignation is increasingly seen by markets as a matter of timing. Local media speculate it could happen as early as this week, with one potential flashpoint being Friday’s extraordinary parliamentary session. Ishiba has consistently denied plans to step down, but pressure from his Liberal Democratic Party (LDP) is mounting.
Some reports suggest Ishiba might remain in office until after an August 15 ceremony marking 80 years since the end of World War Two or until the LDP compiles a report next month on its upper house defeat.
If a leadership race unfolds, Sanae Takaichi—a reflationist who narrowly lost to Ishiba in the last contest—could emerge as a candidate, a scenario that bond investors view with caution.
Regardless, the government’s weakened position may necessitate expanding the coalition or cooperating with opposition parties, with both scenarios likely leading to more dovish policies.
RATE HIKE EXPECTATIONS
Immediate policy changes are not expected by the BOJ this Thursday, though the U.S. trade deal has improved the economic outlook, boosting expectations of a rate hike later this year, possibly in October.
Investors will closely monitor the BOJ’s quarterly outlook report and Governor Kazuo Ueda’s post-meeting press conference for signals on policy normalisation. Policymakers have indicated they are waiting for more data to assess the impact of earlier trade frictions, but the trade agreement has reinforced the view that rate hikes may resume soon.
A return to policy normalisation would not only raise lending rates but also signal the central bank’s continued retreat from its bond purchase programme. This shift places greater responsibility on the finance ministry to manage market stability.
Finance minister Katsunobu Kato on Monday acknowledged the need for new JGB buyers to fill the void left by the BOJ. In May, the ministry mitigated market volatility by adjusting bond issuance toward shorter maturities, but recent selling ahead of elections underscores lingering concerns.
