Japan PM's political doom loop worsens her fight with markets

A $60B Vote of Confidence

Japanese Prime Minister Sanae Takaichi's approval rating has slumped to the lowest since she took office last year due to rising inflation and high import costs from a weak yen. Her strong advocacy of fiscal stimulus and harsh criticism of higher interest rates have heightened investor concerns about worsening public finances in Japan, sending bond yields higher.

The communication challenge created by Takaichi's competing demands for a pro-growth agenda and fiscal discipline has led to unwanted market volatility, making policy implementation more difficult. For example, her spending plans, aimed in part at easing rising household living costs, lifted bond yields to three-decade highs in July on concern over Japan's worsening finances.

Mindful of such market pressures, Takaichi told a news briefing on Monday the administration would seek to gain market trust in Japan's finances through transparent communication. However, when pressed about her administration's sliding approval ratings, Takaichi stressed her determination to break Japan's 'excessive fiscal tightening' with big investment, a sign she had no plans to back down on expansionist policy.

Those challenges could worsen ahead of a host of events that could ignite a renewed spike in yields. Despite reservations voiced even within her ruling party, Takaichi is set to proceed with a plan to cut by two years an 8% levy on food, domestic media reported. While the move would come as little surprise, a lack of funding clarity could further upset bond markets, analysts say.

The government also plans to avoid setting caps on spending requests for key growth areas in an overhaul of budget drafting that could boost expenditure and debt issuance next fiscal year. 'Takaichi tried to explain how her administration was mindful of the need for fiscal discipline. But her policies themselves won't change much, so there's not much hope in bond markets that things could change,' said Atsushi Takeda, chief economist at Itochu Research Institute.

Why Markets Are Gaining Control

The administration's dovish fiscal and monetary approach has also caused headaches in the currency market with the yen sliding to a four-decade low. Although Finance Minister Satsuki Katayama's repeated threats of 'decisive' action have kept markets on edge, they have failed to give a sustained boost to the sagging currency.

Top currency diplomat Atsushi Mimura, who decides how and when to intervene, has stayed quiet since the record $72 billion intervention conducted between late April and early May that did little to arrest the yen's downtrend. The communication strategy has shifted away from yen jawboning to giving the bond market more of the clarity it needs.

The Road Ahead

Katayama said on Tuesday the government has no plan to set a ceiling for annual debt issuance, but would keep the amount 'within a range investors would view as reasonable.' Takashi Fujiwara, chief fund manager at Resona Asset Management's fixed income investment division, said Katayama was positive for the JGB market as she could communicate with the market logically.

'The government's communication on the JGBs is increasing, and that is because every time the government announces something new, there is a 'shock' in the market, and that subsequently weakens the yen,' Fujiwara said.

Takaichi and Katayama are now pitching the administration's expansionary fiscal policy as boosting Japan's growth potential, thereby helping enhance the appeal of the yen and JGBs. For now, markets remain unconvinced with yields on track for further rises amid looming prospects of bigger debt issuance that would strain Japan's already worsening finances.