By Kevin Buckland
TOKYO, Feb 2 (Reuters) – Japanese Prime Minister Sane Takaichi faces a significant market test in the final run-up to this weekend’s election where he hopes a decisive victory will give him a mandate for expansionary fiscal policy.
The Finance Ministry will auction about 700 billion yen ($4.5 billion) worth of 30-year government bonds on Thursday, three days before voting begins.
It’s a tenor that has been hyper-sensitive to concerns about a slowdown in fiscal restraint, facing a rout last month as investors balked at Takaichi’s promise to suspend consumption taxes on food.
The auction has been a particular flashpoint for investors concerned about Japan’s financial situation, which is among the worst in the developed world with debt at 230% of total GDP.
In four of the last five 30-year bond sales, yields hit fresh record highs following the auction results or immediately following.
That includes a sharp sell-off on Oct. 7, which came three days after Takaichi — known as an acolyte of the late Prime Minister Shinzo Abe’s “Abenomics” policies — won a leadership contest of the ruling Liberal Democratic Party and was installed to become prime minister.
Bond yields move inversely to prices.
“This auction essentially serves as a referendum on how investors feel about financial risks from the election,” said Shoki Omori, chief desk strategist at Mizuho Securities.
“I would say demand at the auction may be on the weak side, because investors are going to be cautious. And they have a right to be,” Omori added, suggesting that yields could rise after the auction.
Concerns are evident in the duration premium – the compensation investors demand for holding bonds over long periods of time. Omori said he sees the premium for the 30-year term standing at 2.8 percentage points, “similarly slower” than the 1.6 percentage points for 10-year JGBs.
It will be the first 30-year debt sale since Takaichi called a snap election on January 19 and promised to suspend the sales tax – and bond markets are likely to be on edge after the latest newspaper polls suggest his LDP is poised for a big win.
Tuesday’s auction of 10-year notes will give an earlier indication of investor appetite for government debt, although the tenor is more liquid and attracts a wider range of investors so tends to be less volatile.
The benchmark 30-year JGB yield hovered at 3.63% on Monday – down from a record high of 3.46% on January 20, but still up about half a percentage point from where it was in early October.
Japan’s sovereign bond market is heavily funded by domestic investors and is not at real risk of capital flight.
However, offshore accounts – mainly hedge funds – are playing a larger role in Japan’s longest-dated bonds, adding to volatility in the historically docile market as they fill the void left by traditional buyers such as life insurers and pension funds.
Foreign investors accounted for about 46% of trading in super-long cash JGBs in December last year, the most recent data from the Japan Securities Dealers Association showed, up from 13% a year earlier.
“At the super-long end, there aren’t real money investors. It’s fast money,” said Chris Ciscluna, head of research at Daiwa Capital Markets Europe, adding that a steady fall in prices has put Japanese buy-and-hold investors on edge.
“When you see such significant volatility, you don’t want to try to catch a falling knife.”
($1 = 154.8600 yen)
(Reporting by Kevin Buckland; Additional reporting by Rocky Swift; Editing by Raju Gopalakrishnan)
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