Yen's Fiscal Risks Grow as Ishiba Eyes New Stimulus

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Analysts warn there's a risk that instability in Japan’s government bond (JGB) market could hurt the yen.

Yesterday, Prime Minister Shigeru Ishiba hinted that the government might roll out another economic stimulus package.

When questioned in parliament, Ishiba said he would consider tax cuts and more government spending if needed, after consulting with opposition parties.

Since the main opposition parties recently campaigned on boosting fiscal spending to support households, another stimulus plan seems quite likely.

"The size and whether additional JGB issuance would be required will be important. But even if no additional issuance is required it still could unsettle the JGB market and bring back appetite to sell the yen," says Derek Halpenny, Head of Research EMEA at MUFG Bank Ltd.

The JGB market is Japan's bond market, where Japan's government issues debt in the form of bonds to raise money. With inflation rising and the cost of Japan's debt servicing costs rising, fears about Japanese fiscal stability are also increasing.

For markets, the key questions will be how big the fiscal package is and whether Japan will need to issue more government bonds to pay for it. MUFG says that even if no new bonds are issued, the JGB market could still get rattled, which might lead investors to sell the yen

"One-month USD/JPY implied volatility tops the G-7. With public debt near 230% of GDP and fresh supply on the horizon, further yen weakness cannot be ruled out," says Harun Thilak, Head of Global Capital Markets NA at Validus Risk Management.

Political uncertainty is begetting fiscal uncertainty as investors question Japan's path. A decades-long period of low inflation allowed Japan to borrow significant amounts, but now that inflation is rising again, the Bank of Japan will have to raise the cost of borrowing.

The ability of the government to oversee sound fiscal policy in this time of transition has been severely hampered by the ruling coalition's loss of power in recent elections that means it must work with opposition parties who would try and pursue more populist policies.

This threatens the sustainability of government debt, and the domestic currency.

"The yen, traditionally a safe-haven currency, has swung sharply this year. It firmed against the US dollar in Q1 as the greenback sagged, but fresh political uncertainty and trade friction have since sent it lower. Markets now fear bigger deficits and softer policy, both potential headwinds for the currency," says Thilak.