Japan’s Cabinet has approved its first economic and fiscal guidelines under Prime Minister Sanae Takaichi, pivoting towards “responsible and proactive” spending and away from near-term fiscal consolidation. The plan frames the next fiscal year from April as year one of this approach and sets an ambition of ¥370tn in combined public-private investment by fiscal 2040 across 17 areas, with semiconductors a central focus. It also creates a new budget allotment from fiscal 2027 and drops the traditional single-year primary surplus objective, instead aiming to steadily reduce the debt-to-GDP ratio over time. Targets include real growth above 1% and nominal growth above 3%, while a decision on a potential food tax cut is due by early August; monetary policy is reiterated as the responsibility of the Bank of Japan (BoJ).
On the flows side, Japanese insurers bought the most super-long JGBs in three years in June, pointing to firmer demand as yields became more attractive after peaking in mid-May. Life and casualty insurers purchased a net ¥630.5bn of JGBs with maturities over 10 years, the largest monthly total since July 2023. Separately, overseas investors sold the most 2y and 5y notes since December 2022, as demand softened after the BoJ raised rates in mid-June and signalled further hikes if the economy warrants.
Fiscal Expansion And Currency Volatility
As we navigate the market shift following Prime Minister Takaichi’s aggressive fiscal guidelines, we see a massive departure from traditional Japanese austerity. With Japan targeting a massive ¥370 trillion in public-private spending by 2040, fiscal expansion is set to redefine the yen’s trajectory. We expect this structural shift to inject significant volatility into the currency markets over the coming weeks.
The Bank of Japan’s recent rate hikes have pushed short-term yields higher, while local life insurers recently purchased ¥630.5 billion in super-long JGBs. This tug-of-war between rising short-term policy rates and heavy domestic buying at the ultra-long end creates a prime environment for yield curve options. We recommend derivative traders position for a flattening yield curve using JGB futures options, as domestic institutional demand anchors the long end.
Derivative Opportunities And Fixed-Income Risks
Historically, when the BOJ tightens alongside heavy fiscal spending, USD/JPY can experience sharp, multi-week swings of 5% to 8%. To exploit this, we should consider buying USD/JPY put options to hedge against a sudden repatriation of Japanese capital. Alternatively, because implied volatility on near-term USD/JPY options is historically underpricing these policy shifts, long straddle strategies are highly attractive right now.
With the government set to decide on a potential food tax cut by early August, short-term consumer inflation expectations will likely fluctuate. We must also monitor the heavy selling of 2-year and 5-year JGBs by foreign investors, which recently mirrored the capitulation levels seen in late 2022. This exodus of foreign capital from short-term debt suggests we should maintain a bearish stance on short-duration Japanese fixed-income derivatives.
