Japanese Prime Minister Takaichi’s budget remarks sent a “red flag” to bond markets

Japanese Prime Minister Sanae Takaichi is putting together an extra budget to help families with living expenses, but it has also raised doubts about whether she can stick to her promises on debt relief.

The budget was largely in line with market expectations, at around 3 trillion yen ($19 billion), but comes as Japan continues to struggle with high energy prices, rising subsidy costs, and a weak yen.

The budget also marks a reversal of his earlier position that more money was not needed. He also said the total amount of bond issuance for the 2026 calendar year would remain unchanged in the original budget plan, according to Bloomberg.

Takaichi wants to allay anxiety in the bond market, saying the extra cash will be financed by issuing deficit-covering bonds. But the Japan’s 10-year sovereign bond The yield rose to 2.809% on May 20, the highest since 1996, after reports that the government may issue new debt to finance the additional budget.

“Bond markets are a lot of things, but they’re not stupid,” said Jesper Koll, managing director at Tokyo-based financial services firm Monex Group. “You can’t increase spending without increasing debt.”

Takaichi’s use of the calendar year caught the attention of Japanese viewers.

“Nobody in Japan has ever made policy on the basis of a calendar year,” Koll said, noting that historically the country’s fiscal calendar ends on March 31. “If there’s ever been a red flag, that’s a red flag.”

Over the course of 10 years to the top ten levels, i 30 year yield rose above 4%, indicating heightened concern not only about financial risks but also inflationary pressures.

“Recent developments – including continued uncertainty in the Middle East, rising commodity prices, and rising fuel subsidies – have contributed to bond markets’ concerns about Japan’s financial situation this year,” said Louis Chua, Asia equity research analyst at Julius Baer.

Investors might have had more confidence, Koll said, if the government had clearly announced a 10 billion yen budget funded by 10 billion yen, instead of a smaller package laced with assurances of no more spending.

“The first is, actually, people believe,” Koll said. “Second, no one believes.”

However, not all analysts see the package as disruptive.

State Street Investment Management remains “well-positioned in Japan, the economy and the markets,” according to APAC economist Krishna Bhimavarapu. “The additional budget looks less like a broad stimulus and more like targeted cuts for families facing energy-driven price pressures related to the Iran conflict.”

“That keeps it in line with Prime Minister Takaichi’s philosophy instead of a big demand boost,” he added.

Recent data has reinforced that view. The economy grew at a 2.1% annual pace in the first quarter, while real GDP rose 0.5% from the previous quarter. Exports rose 14.8% in April from a year earlier, helped by strong semiconductor shipments and AI-related demand.

Even Koll sees a continuation of the budgets, due to corporate restructuring, record mergers and acquisitions, activist investors, private equity and domestic business investments.

But with bonds and the yen, the calculus is different. The currency remains close to 160 against the dollar, an area often seen as a potential trigger for intervention.

As for the bond market, it seems to indicate that inflation, BOJ rate hikes and bond hikes are becoming “increasingly certain,” Koll said.