Japan's election puts its massive bond market back in the spotlight

• Japan's bond yields rose after Prime Minister Sanae Takaichi secured a strong election mandate.
• Her landslide win clears the way for big spending, reviving public debt concerns.
• Her snap election call last month had already rattled Japan's bond market, and in turn, global markets.

Japan's bond market is back under scrutiny after Prime Minister Sanae Takaichi's landslide election victory pushed government bond yields higher, even as stocks surged to record highs.

On Sunday, Japan's ruling Liberal Democratic Party secured a decisive win in the general election, giving Takaichi a clear mandate and room to pursue her fiscal agenda.

That agenda includes increased government spending on defense and social welfare, alongside tax cuts — policies markets have long debated for their impact on Japan's already heavy public debt burden.

Following Takaichi's win, Japanese equities surged nearly 6% to record highs on optimism around fiscal support for growth.

Bonds, however, moved in the opposite direction. Two-year Japanese government bond yields climbed to their highest level in three decades, while benchmark 10-year yields also rose. Bond prices fall when yields rise.

Longer-dated bonds sent a more mixed signal. Japan's longest-maturity debt — typically the most sensitive to concerns about fiscal sustainability — erased mostly early yield spikes. Yields on 30-year bonds were little changed on the day around midday in Japan, after surging to record highs last month.

Japanese bond yields matter far beyond the country's borders because of Japan's outsize role in global capital flows. Years of ultra-low yields have allowed domestic and foreign investors to borrow cheaply and leverage bets on higher-yielding assets such as US Treasurys and stocks.

That dynamic has refocused attention on how markets are pricing Japan's fiscal and debt risks under Takaichi's leadership.

"A bigger mandate is likely to fuel concerns about the potential path of spending plans, warranting renewed weakness in JGBs and the Yen, unless the BoJ were to shift towards faster rate hikes," wrote Goldman Sachs analysts in a note on Saturday before the polls.

The Goldman analysts wrote that they expect volatility as markets digest the news.

Last month, Takaichi's call for a snap election rattled global markets and triggered a sharp sell-off in Japanese government bonds, as investors worried her fiscal agenda could further strain public finances.

Analysts at the time warned the move could serve as a cautionary signal for other heavily indebted governments, as rising bond yields risk pushing up borrowing costs across the economy.

Takaichi has since sought to reassure markets. She said she would pursue a sustainable and responsible fiscal policy and would not rely on deficit-covering sovereign bond issuance to fund a two-year suspension of the food consumption tax.

Japanese government bond yields could still rise further, driven by concerns about increased government spending on areas such as defense and AI, according to Min Joo Kang, a senior economist at ING.

Not all analysts agree that the postelection bond sell-off will last. Vishnu Varathan, Mizuho's head of macro research, excluding Japan, said Takaichi's strong election win gives her the political room to avoid messy policy trade-offs and make clearer, more sustainable decisions about government spending.

He also pointed to Japan's external balance sheet as a key buffer, arguing that domestic investors can redirect capital back into local markets.

"Japan's significant holdings of foreign assets (as the world's second largest net creditor) puts it in pole position to re-allocate back home to Japanese assets to the benefit of JPY, JGBs and equities," Varathan wrote.