As Japan's Ishiba Steps Down, The Bond Vigilantes Step Up

Latest stories

US rushing drones to carriers to blunt China's missile edge

'Skull Chart' math behind Trump's climbdown on all things China

Trump shows S Korea who's boss with Hyundai plant raid

The volatility culminated with a failed 20-year bond auction. The typically routine sale of US$6.9 billion issues maturing in 2045 drew the least interest since 2012. The“tail,” gap between the average and lowest-accepted prices, was the worst since 1987.

Suddenly, #JGBCrash was trending in Asian cyberspace. It was Tokyo returning the favor, sending shockwaves back toward the US. In late May, US Treasury Secretary Scott Bessent expressed concern that turmoil in Japan was pushing US yields higher, the way Treasury market turmoil had unnerved Japan earlier that month.

That same month, Ishiba hardly helped things by saying that Japan's deteriorating finances are“worse than Greece .” It put Japan in global headlines for all the wrong reasons at the worst possible moment.

Ishiba was making a more nuanced point than that. His argument was aimed at lawmakers planning to cut taxes. Ishiba framed it as a luxury Japan couldn't afford, given its lack of fiscal space. Yet his gaffe went viral in market circles - in the worst possible ways. No doubt it drew the attention of credit-rating companies everywhere.

Yet some observers think investors' worries are overdone. Masahiko Loo, senior strategist at State Street Global Advisors, notes that around 90% of JGBs are domestically held, and the 'don't fight the BOJ/Ministry of Finance ' mantra remains a powerful anchor.

Any perceived supply-demand imbalance is more a matter of timing mismatches, which is a technical dislocation rather than a fundamental flaw. We expect these imbalances to be resolved” as early as the current quarter.

Recently, though, the 20-year JGB rate rose to 2.655% , the highest level since 1999. It sparked a level of volatility Tokyo markets haven't seen in years.

Since 1999, a succession of BOJ leaders have been trying to get short-term rates closer to 1% than 0%. To no avail. Today's BOJ Governor Kazuo Ueda has gotten no further away from zero than his peers during an earlier 2006-2007 tightening cycle.

“There may be growing expectations that macroeconomic policy could tilt toward easing among foreign investors in particular,” says Takeshi Yamaguchi, economist at Morgan Stanley MUFG. But, he adds,“regardless of the political situation, if weak US economic data- including employment data-continue, the bar for the BoJ to raise rates will likely become higher.”

Could the BOJ's next move be to cut rates, not raise them? It's possible given the widening fallout from Trump's tariffs. Yet investors have every reason to worry that a new government in Tokyo will change little about the direction of Japanese politics and the economy.

“Regardless,” say economists at BMI, a unit of Fitch Solutions,“the next prime minister would still face the same problematic legislative dynamics as Ishiba, unless a bigger coalition is formed.

“We thus see a possibility that a new LDP premier could seek to take advantage of their putative honeymoon period to call a snap general election, with the aim of at least recovering the LDP's majority in the House of Representatives. Even so, this would be a gamble, as Ishiba himself discovered when he inadvertently led the LDP into a lower house minority position in October.”

The frontrunners to replace Ishiba are LDP party mates Shinjiro Koizumi and Sanae Takaichi . At 44, Koizumi, former environment minister and scion of a political dynasty, represents generational change. Then-Economic Security Minister Takaichi, 64, would be the nation's first female leader.

David Boling, an analyst at Eurasia Group, expects moderates within the LDP to rally around Koizumi, known for his youth and charisma, while conservatives are expected to support Takaichi, a staunch nationalist and apostle of Abenomics,” a mix of loose monetary and fiscal policy championed by 2012-2020 Prime Minister Shinzo Abe.

“Investors will closely watch Takaichi's electoral prospects because of her previous pointed criticism of the Bank of Japan's plans to raise interest rates, and her support for larger fiscal stimulus,” Boling notes.

Yamaguchi notes that many investors, especially foreign ones, believe that if Takaichi becomes the next prime minister, fiscal and monetary policy may shift toward expansion.”