Political uncertainty is weighing on the demand for Japanese bonds

Bonds are financial instruments that attract conservative investors during periods of stability but become targets of concern during times of political fluctuations. This is exactly what we observe in Japan, where upcoming House of Representatives elections have significantly cooled investors’ appetite for government debt.

What’s happening in the Japanese bond auction

On February 3, Jin10 reported a notable decline in demand for 10-year Japanese government bonds. The bid-to-cover ratio was only 3.02 — the lowest in the past year. For comparison, the previous auction saw this ratio at 3.30, and the 12-month average remained at 3.24. The tail spread remains unchanged at 0.05, but the demand dynamics clearly indicate market caution.

Elections as a catalyst for market uncertainty

The source of concern lies in the political sphere. Elections for the House of Representatives will take place on February 8, and traders are already preparing for possible volatility. According to recent polls, Japan’s ruling coalition could secure about 300 out of 465 seats, with the Liberal Democratic Party most likely to achieve an outright majority on its own. Such a scenario would allow Prime Minister Sanae Takaichi to accelerate the implementation of the fiscal stimulus plan, which would inevitably lead to an increase in government debt — precisely what worries bondholders.

Why debt is growing: tax plans and their consequences

Recent proposals to ease consumption taxes have pushed Japanese bond yields to multi-year highs. Although these figures have slightly retreated since then, the baseline yield on 10-year bonds remains near 2.25% — the highest level in nearly three decades, dating back to 1999. This rise in yields reflects investor concerns about increasing debt burdens on the budget.

Market expectations for the coming months

Financial markets have already priced in certain assumptions about central bank actions. Currency swap indices indicate a 76% probability of rate hikes by April this year. Moreover, the market fully accounts for the possibility of a 25 basis point increase by June. This calculation shows that market participants expect active monetary policy responses to fiscal expansion, creating complex dynamics for bonds and requiring investors to pay close attention to risks.