Japanese government bonds may have recovered from their jarring sell-off last week, but market participants will not easily forget the day when long-end yields shot up by 30bp-40bp in what used to be considered one of the world's most liquid and stable markets.
The trigger was obvious — a snap election called by prime minister Sanae Takaichi and her pledge to cut taxes and increase defence spending if re-elected. But the episode once again highlighted a fundamental concern for global investors, which is not exclusive to Japan: faltering fiscal discipline and deteriorating public finances.
The long end of the US Treasury market was caught up in the selling last week, though the yield differential has continued to narrow, leaving 30 year JGBs at around 3.6% and USTs about 4.85%. At one point the gap got as tight as 100bp. Three months ago it was 160bp, a year ago, 250bp.
Even though the Federal Reserve forbore to cut rates this week, it is expected to this year, while the Bank of Japan may tighten policy by accelerating quantitative tightening or hiking rates. That could keep the gap narrow — and if JGBs can stabilise it could make them appealing.
Some believed the European government bond (EGB) market was also affected by the JGB disarray last week, but to a much lesser extent.
Investors seem less worried about Europe's debt sustainability than the US's.
The European market could end up benefitting from the volatility in the two other major government bond markets.
Good news for Japan is that higher JGB yields could tempt money — including Japanese money — back to the market. Much of that would likely come out of Treasuries, where Japan has long been the largest foreign holder. Its store of EGBs is much more modest.
And the dollar's long slide against the euro could also prompt investors to move chips to Europe.
With volatility continuing in the Treasury market and a highly uncertain US trade policy, EGBs have over the past year proved one of the more stable of safe haven markets globally.
The latest JGB spasm, from which EGBs were fairly insulated, was a fresh reminder to investors that EGBs are enjoying the spotlight on the world stage.
