Japan's Bond Market Rattled by Snap Election Call

Japan's bond market is flashing warning signs as Prime Minister Sanae Takaichi has called a snap national election for February 8. The move sent long-term Japanese government bond yields surging by as much as 10 basis points, pushing them to new highs and fueling a rally in gold to prices above $4,600.

The chart shows a sharp upward trend in Japanese government bond yields across all major long-term maturities since early 2021.

The market's reaction is a direct response to Takaichi's proposed platform, which centers on increased government spending, significant tax cuts, and a new national security strategy poised to accelerate defense expenditures.

A correlated rise in Japan's 10-year bond yield and spot gold prices since late 2022 highlights investor response to the country's shifting economic policy.

Takaichi's High-Stakes Fiscal Gambit

Prime Minister Takaichi, who became Japan's first female premier in October, plans to dissolve parliament on Friday ahead of the vote for all 465 seats in the lower house. "I am staking my own political future as prime minister on this election," Takaichi stated at a press conference on Monday. "I want the public to judge directly whether they will entrust me with the management of the nation."

Prime Minister Sanae Takaichi announced the snap election to seek a public mandate for her economic and security agenda.

Her economic proposals include a two-year suspension of the 8% consumption tax on food, a measure the government estimates will reduce its revenue by 5 trillion yen ($32 billion) annually. In response to this prospect, the yield on Japan's 10-year government bonds climbed to a 27-year high earlier on Monday. Takaichi argues her spending plans will stimulate job creation, boost household spending, and ultimately increase other tax revenues.

The early election is a strategic move to solidify her political standing, leverage strong public support, and strengthen her control over the ruling Liberal Democratic Party (LDP) and its coalition.

Inflation and National Security Drive Policy

The election will test voter sentiment on higher government spending at a time when the rising cost of living has become the primary public concern. After nearly four decades of deflation, Japan is now grappling with accelerating prices. A recent poll by public broadcaster NHK found that prices are the top worry for 45% of respondents, with diplomacy and national security trailing at 16%.

Further adding to spending pressures, Takaichi's administration is planning a new national security strategy. This includes a decision to increase military spending to 2% of GDP, a significant departure from the post-war cap of around 1%. This move is driven by rising tensions with China over Taiwan and disputed islands, as well as pressure from the United States for allies to increase their defense commitments. China recently banned exports to Japan of certain critical minerals with both civilian and military applications.

"China has conducted military exercises around Taiwan, and economic coercion is increasingly being used through control of key supply-chain materials," Takaichi noted. "The international security environment is becoming more severe."

The Political Landscape

Going into the February 8 election, the LDP and its partner Ishin hold a combined 233 seats. Takaichi's goal is for the coalition to maintain its majority in the lower chamber.

Her main opposition is the Centrist Reform Alliance, a new party formed by the Constitutional Democratic Party of Japan and Komeito, which ended its 26-year coalition with the LDP after Takaichi became its leader. Together, these opposition parties hold 172 seats and have floated the idea of permanently abolishing the 8% sales tax on food.

"Now may be the best chance she has at taking advantage of this extraordinary popularity," said Jeffrey Hall, a lecturer at Kanda University of International Studies. However, he noted that with opposition parties joining forces, a victory may not be guaranteed.

The Yen's Plight and the BOJ's Dilemma

Amid this political uncertainty, the Japanese yen is trading near an all-time low against the U.S. dollar and is also at its weakest point against the Chinese yuan since 1992.

The Japanese yen has fallen to its lowest level against the Chinese yuan in over three decades, reflecting significant currency weakness.

This currency weakness helps keep Japan's export-driven economy competitive by making its goods cheaper abroad. However, it puts the Bank of Japan (BOJ) in an increasingly difficult position. The central bank, which holds approximately 60% of the Japanese bond market, faces a critical choice: either raise interest rates to contain inflation, which would likely cause the yen to surge, or continue its bond-buying program to suppress yields, risking further currency depreciation and an overheating economy.