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Consumption tax cut race fuels JGB market volatility
Long-term and super-long-term JGB yield scenario for January 26-30
We expect the technical correction (decline) in the 10-year JGB yield following its recent surge to wind down in the week of January 26. The market may struggle to find a clear sense of direction while it monitors developments in the consumption tax cut debate between the ruling and opposition parties. Last week, Prime Minister Sanae Takaichi’s declaration of her intention to exempt food and beverages from the consumption tax for a period of two years prompted a significant rise in long-and super-long-term JGB yields. The yield on the newly issued 10-year JGB briefly surged to 2.380%, while the yield on the newly issued 30-year bond climbed as high as 3.880%. On January 20 (US time), US Treasury Secretary Scott Bessent commented on the unusually severe decline in the JGB market, and Finance Minister Satsuki Katayama stated that necessary measures would be taken to ensure market stability. The emergence of a (slight) sense of relief that the alarm signals being sent by the bond market had finally reached policymakers in both Japan and the United States helped long- and super-long-term yields turn lower toward the end of the week. Following the historically sharp rise in rates, some market participants appear to have tentatively begun buying on dips.
That said, the Lower House election has yet to begin in earnest, with campaigning starting on January 27 and voting set to take place on February 8. Attention will focus on the consumption tax cuts pledged by both ruling and opposition parties(Tables 1 and 2). Finance Minister Katayama has stated that the government “will not rely on special deficit-financing bonds” to fund such a cut, but she has yet to provide any details. In her January 19 press conference, Prime Minister Takaichi announced that after the election she intends to promptly establish a supra-partisan “National Conference” to discuss comprehensive social security and tax reforms. She further stated that this body would “accelerate consideration” of a consumption tax cut, including the funding and scheduling of such a measure. It appears that substantive discussions on sources of funding will be deferred for now. The opposition Centrist Reform Alliance (CRA) has identified government funds, special account surpluses, and returns from government investment funds as potential revenue sources, but we do not think these would be sufficient to reliably finance a permanent reduction in the consumption tax (as pledged by the CRA).
We suspect that what surprised bond investors at Prime Minister Takaichi’s press conference on January 19 was not only her pledge to cut the consumption tax rate but also her view of the current fiscal situation. Ms. Takaichi declared her intention to “put an end to overdone fiscal austerity” and announced a plan for committing to fiscal stimulus over several fiscal years, premised on extensive results-based management. While she also stated that “new policies will not be funded by borrowing,” the precise nature of the new budgeting framework to be introduced starting in FY27 remains unclear at this stage. Markets are constantly confronted with new themes, and there may come a point when fiscal issues lose their novelty. But for now, uncertainty surrounding the fiscal outlook may continue to weigh on the bond market. In the week of January 26, we expect to see the bull flattening move observed in the super-long sector in the latter half of the previous week winddown. The curve might also undergo a bear steepening (in a reversal of recent action) around the 40-year JGB auction on January 28.