The relentless pressure on JGBs this year has been pinned on the persistent overshoot of inflation. Careful what you wish for: years of fighting deflation has perhaps blinded the Bank of Japan to the harsh reality, that inflation is a much bigger threat to society. In particular, it is much more damaging for the sustainability of public sector finances. The rise in JGB yields has surpassed expectations this year, putting even more upward pressure on debt interest payments.
It is worth reviewing the Government’s draft budget for FY2025 again, which was published in December last year, to understand what is at stake. Indeed, the Ministry of Finance forecast that ‘general expenditures’ would have to rise 0.69% this current fiscal year (FY2025) to Y68.245tr. This does not include debt interest. It is worth noting, that draft budgets have historically been underestimates of total spending. Furthermore, the upward, systemic pressures on ‘general expenditures’ are not reflected in these initial numbers.
Supplementary budgets have for years allowed Japanese governments to kick the can down the road: but they chip away at the credibility of Ministry of Finance draft budgets, leaving JGB investors deeply sceptical of claims that debt to GDP is on a downward trajectory. This is why JGBs are so vulnerable. For sure, real yields that were ‘deeply’ negative made no sense, particularly when wage pressures were starting to emerge, in response to adverse demographics. But as regular readers will know, it is not higher inflation per-se that destabilises public sector finances: it is a rise in term premiums to reflect distrust in politicians, who proffer meaningless, fanciful budgets.
The West is variously experiencing acute pressures on public sector finances and a realisation that real yields, when they normalise, can go up all too quickly. JGBs face the biggest adjustment of all debt markets.
