Japanese elections exacerbate concerns over deficits; analysts provide reassurance: two major factors are "safeguarding" Japanese bonds.

Japan's election results have made the possibility of increased government spending and expanded fiscal deficits a reality, but analysts say that continued inflow of foreign funds and economic growth can prevent a substantial increase in Japan's bond yields. Japanese elections exacerbate deficit worries With the deadline for U.S. tariffs looming, the ruling coalition and Prime Minister Shindzo Abe suffered a crushing defeat in Sunday's upper house election. The results show that the ruling coalition lost its majority in the upper house in this election. Investors are preparing for various possible scenarios, such as Abe continuing to lead a minority government, reaching agreements with smaller opposition parties, or even being dismissed himself. But undoubtedly, Japan will face tax cuts and larger fiscal deficits. Under normal circumstances, this should lead to a decline in Japanese bond prices and an increase in yields, as investors demand higher returns. Japan's debt exceeds $8 trillion, nearly 2.5 times its economic size. Although Japan's long-term bond yields have been rising, they have not reached levels that reflect excessive government spending. The yield on Japan's 30-year bonds is only 3%. Factors such as a weak yen, the legacy impact of low interest rates, Japan's return to inflation, massive domestic savings, and Japanese central bank policies collectively support Japan's government bond yields. Analysts expect this support for bonds to continue. Michael Wan, senior currency analyst at Mitsubishi UFJ Financial Group, said, "With the introduction of some proposals and changes in political dynamics, more people may call for fiscal support, including consumption tax." But Wan and other analysts point out that Japan's economic growth over the past three years and overcoming deflation are reasons why its debt burden is manageable and may decrease in the coming years. Marcel Thieliant, Chief Economist for Asia-Pacific at Capital Economics, said in a report, "Japan's fiscal situation is not as bad as many people think." He said that while Japan's debt-to-GDP ratio is the highest among all major economies, its net debt level is much lower. Wan of Mitsubishi UFJ Financial Group said, "Compared to other countries, Japan is a net creditor. Therefore, theoretically, Japan has a lot of idle funds, which come from overseas investments by domestic institutions. These funds to some extent can stabilize the situation of significant fluctuations in yields in the medium term." Inflows of foreign funds As one of the world's largest creditors, Japan stands in sharp contrast to G7 member countries such as the UK and the U.S. that are heavily indebted and experiencing rising bond yields. Japan's total overseas investment amounts to approximately $3.6 trillion, with half of it invested in U.S. assets. While Japan can tap into its massive domestic savings when necessary, its low interest rates and weak currency are currently attracting foreign investors. These investors can convert dollars or euros into yen and gain interest differentials through currency swaps. For example, investors can convert dollars into yen, then invest in one-year Japanese government bonds, which yield about 30 basis points higher than the 3.9% yield on one-year U.S. government bonds. Rong Ren Goh, fixed income team investment manager at Eastspring Investments, said, "Global fund managers or index investors actually view developed markets as a relative value investment opportunity, choosing to invest in markets with the highest growth." The steepening of the Japanese government bond yield curve has attracted many bond investors. Foreign investors have poured more than 15 trillion yen (about $101.7 billion) into the Japanese bond market so far this year. The yield on Japan's 30-year bonds has risen 80 basis points this year, reaching a record high, and the yield curve is at its steepest level in years, with a spread of over 150 basis points between 10-year and 30-year bonds. Thieliant of Capital Economics still expects that by the end of 2026, the yield on Japan's 10-year government bonds will rise from the current approximately 1.5% to 2%, based on the assumption of a firm monetary policy stance.