Japan PM Takaichi’s budget remarks send `red flag’ to bond markets

Japanese Prime Minister Sanae Takaichi is compiling a supplementary budget to help households with the cost of living, but it’s also created skepticism about whether she can stick to her promises about debt issuance.

The budget was largely in line with market expectations, at about 3 trillion yen ($19 billion), but comes as Japan still struggles with higher energy prices, rising subsidy costs, and a weak yen.

The budget also marks a reversal from her earlier position that extra spending was not needed. She also said the total bond issuance for the calendar year of 2026 would remain unchanged from the original budget plan, according to Bloomberg.

Takaichi has sought to dispel worries in the bond market, saying that the extra spending would be financed by issuing deficit-covering bonds. But the 10-year Japanese sovereign bond yield rose to 2.809% on May 20, its highest since 1996, after reports that the government may issue fresh debt to fund the extra budget.

“Bond markets are a lot of things, but they’re not stupid,” said Jesper Koll, expert director at Tokyo based financial services firm Monex Group. “You cannot increase spending without increasing debt.”

Takaichi’s use of the calendar-year time frame has gotten the attention of Japan watchers.

“Nobody in Japan has ever made policy on the basis of the calendar year,” Koll said, noting that historically the country’s fiscal calendar ends March 31. “If there ever is a red flag, that is a red flag.”

In addition to the 10-year’s move to four-decade highs, the 30-year yield has moved above 4%, reflecting heightened concern over not only the fiscal risks but also inflation pressures.

“Recent developments — including continued uncertainty in the Middle East, elevated commodity prices, and rising fuel subsidy outlays — have contributed to bond market concerns about Japan’s fiscal position this year,” Louis Chua, equity research analyst for Asia at Julius Baer, said.

Investors might have had more confidence, Koll said, if the government had openly announced a 10 trillion yen budget funded by 10 trillion yen of bonds, rather than a smaller package paired with assurances of no additional issuance.

“The first one, actually, people believe,” Koll said. “The second one, nobody believes.”

However, not all analysts see the package as disruptive.

State Street Investment Management remains “structurally bullish on Japan, both on the economy and markets,” according to APAC economist Krishna Bhimavarapu. “The supplementary budget looks less like broad stimulus and more like targeted cushioning for households facing energy-driven price pressures linked to the Iran conflict.”

“That keeps it consistent with Prime Minister Takaichi’s philosophy rather than a large-scale demand boost,” he added.

Recent data have strengthened that view. The economy expanded at an annualized 2.1% pace in the first quarter, with real GDP up 0.5% from the previous quarter. Exports rose 14.8% in April from a year earlier, helped by strong semiconductor shipments and AI-related demand.

Even Koll sees continued upside for equities, thanks to corporate restructuring, record mergers and acquisitions, activist investors, private equity and domestic business investment.

But for bonds and the yen, the calculus is different. The currency remains near 160 versus the dollar, an area often regarding as a potential trigger for intervention.

As for the bond market, it appears to reflect that inflation, BOJ rate hikes and increased bond supply are becoming “increasingly certain,” Koll said.