Japan in Focus: New Leadership, Bold Budget

This week, Japan grabbed attention with its largest supplementary budget since the pandemic. Prime Minister Sanae Takaichi’s government unveiled a ¥135 trillion (£632 billion) package aimed at boosting strategic growth sectors, strengthening defence capabilities, and creating a reserve for emergencies such as natural disasters.

Market Reaction

Japanese equities showed a modest response, ending the week slightly higher and maintaining their year-to-date outperformance versus other major markets. This fiscal backing, together with ongoing corporate reforms, continues to make Japan an appealing market for investors.

Bond markets, however, saw more drastic moves. The yield on Japan’s 10-year government bonds (which rises when bond prices fall) climbed to its highest level since 2007, reflecting the growing expectations of a possible interest rate rise by the Bank of Japan in December. Longer-term bond yields also rose, and the 30-year yield briefly hit a record before easing back after more buyers, particularly overseas investors, stepped in.

Why Bond Markets Matter

When a government increases spending, it often needs to borrow more, which means issuing more bonds. More supply can push yields higher, and that’s what we’re seeing in Japan. These moves matter because government bond yields influence wider financial conditions – from how expensive it is for companies to borrow to how investors think about risk. When yields in a large economy like Japan move meaningfully, it can shape decisions in other markets too.

A Broader Global Context

Furthermore, this is important as Japan’s fiscal and monetary moves, made under a right-leaning prime minister, come amid a wider shift in politics across developed economies. In the UK, the Reform Party has been gaining ground in polls, while in Germany, the Alternative für Deutschland shows rising support. This trend toward more conservative or right-leaning parties could influence future policy choices – particularly around tax, spending and regulation.

We’ve seen before how political shifts can affect markets: in 2022, the UK’s “mini budget” under a new Conservative leadership triggered a sharp move in bond markets after plans for unfunded tax cuts raised questions about fiscal discipline. It’s a reminder that investor confidence can change quickly when governments adjust direction.

Putting It Into Perspective

However, before making too many comparisons or predictions, it is important to remember that there are several key differences between Japan and other markets like the UK. Japan’s high debt-to-GDP ratio and decades of near-zero interest rates make its bond market unusually sensitive to shifts in fiscal and monetary policy. By contrast, the UK and other advanced economies have not experienced the same underlying challenges, meaning any similar moves would likely be less dramatic. Therefore, while Japan’s experience is worth monitoring, it is only one part of a much bigger picture and will not, on its own, provide an exact guide to what might happen in the UK or elsewhere.

The Noise

• It was a muted week for markets, with most major markets edging higher, but only marginally. The standout gains came from smaller markets, with Brazil and Spain posting the most notable increases.
• In commodities, natural gas extended its year-to-date rally, reaching a three-year high and climbing 65% since mid-October, driven by strong export demand. Much of this momentum reflects Europe’s continued move away from Russian liquefied natural gas, with countries reaffirming plans to fully phase it out by the end of 2027. Silver also performed well this week, hovering near record highs and up about 100% year-to-date, amid tightening supply and expectations of deeper US Federal Reserve rate cuts.
• The US dollar weakened again, with the Dollar Index – a measure of the dollar’s value against a basket of major currencies – falling as investors priced in an increasingly likely Federal Reserve rate cut. As a result, both the euro and the pound strengthened against the dollar, with the pound reaching its highest level since October.