Goldman warns Japan fiscal plans could spark UK bond sell-off
The fiscal plans touted by the woman poised to become Japan’s first female Prime Minister will trigger a sharp jump the country’s borrowing costs that could spill over into the price of UK and US government bonds, Goldman Sachs has said.
Sanae Takaichi, an admirer of Margaret Thatcher, was swept to victory in her Liberal Democratic Party’s leadership race on a pro-stimulus platform that promised voters cash handouts and tax rebates to help dampen a cost-of-living crisis that has seen wages struggle to keep up with years of inflation.
Those plans present “upside risks” to Japan’s long-term debt, according to a team of Goldman Sachs analysts, which in turn is likely to dampen demand for long-dated government debt across developed economies.
“Ms. Takaichi’s election as LDP President this weekend presents upside risks to long-end JGB yields,” they wrote. “While our economists don’t think a significant boost in fiscal spending is imminent, markets are nonetheless likely to reevaluate the risks around the fiscal outlook. We think 10-15 [basis points] of upward pressure on 30y yields is a plausible initial response, with scope for additional steepening if the market pushes back its expectations for Bank of Japan hikes.”
The investment bank added that if the interest paid on Japanese government bonds were to rise by 10 basis points when pricing in the likelihood of Takaichi’s expansionary fiscal plans, UK government borrowing costs were likely to rise by as much as three basis points.
Investors factor in new look Japan with ‘Takaichi trade’
That coming to pass would provide yet another headache to Chancellor Rachel Reeves as she puts the finishing touches to next month’s crucial autumn Budget, when she is expected to unveil £30bn of tax rises.
The Office for Budget Responsibility (OBR) is currently compiling its all-important forecast that will determine how much breathing room the Chancellor has, and the volume of fiscal tightening needed. And the fiscal watchdog would need to factor any jump in UK government borrowing costs sparked by Takaichi’s spending plan into its estimate.
Investors rapidly readjusted their portfolios to factor in the new direction Japan’s new premier has promised to take the country on Monday, in what has been dubbed the ‘Takaichi trade’. The Nikkei 225 – the country’s blue-chip equities index – continued its recent run of all-time highs, closing up 4.75 per cent.
Both the yen and short-term bonds yields fell on expectations the country’s new political leadership will call for more dovish monetary policy. But bonds at the longer end of the curve – meaning bonds with a longer maturity – sank as investors factored in the higher risk of runaway spending.
The yield on the UK’s 30-year gilts also climbed more than six basis points, as movements across Japan and France spilled over into international debt markets.
“Markets have moved to price in Takaichi’s policies of fiscal stimulus, industrial policy, and a dovish monetary policy view,” said Sree Kochogovindan, senior research economist at Aberdeen.
Goldman’s Zu added that while immediate borrowing-fuelled spending splurge was unlikely, there remained a high likelihood that “she could steer toward fiscal expansion over time”.
The investment bank felt the fresh injection of uncertainty that Japan’s new leadership has ushered in, will keep the country’s long-dated bond yields “more elevated” at a time when long-end demand is already flagging.