Raising interest rates with fiscal expansion overlapped, Japan will reduce the issuance of national debt in 2026 and focus on "reducing long and increasing short."

The Japanese authorities plan to reduce the sale of government bonds in the 2026 fiscal year starting in April of next year, with a focus on cutting ultra-long-term debt. The Japanese Ministry of Finance said on Friday that the total amount of government bonds issued through auctions to institutional investors in the 2026 fiscal year will be 168.5 trillion yen (approximately 1.1 trillion US dollars), a decrease of 3.8 trillion yen from the initial plan of the previous fiscal year. The total sales of 20-year, 30-year, and 40-year government bonds will be reduced by 7.2 trillion yen to 17.4 trillion yen, and according to the initial budget, the issuance of ultra-long-term government bonds will decrease to the lowest level since 2009. At the same time, the issuance of 10-year government bonds will remain unchanged, while the sales of 2-year and 5-year government bonds will increase. As of the time of reporting, the yield on Japanese 10-year government bonds was 2.034%, the yield on 20-year government bonds was 2.959%, and the yield on 30-year government bonds was 3.395%, all slightly decreasing; the yield on 2-year government bonds was 1.187%, rising by about 7 basis points; the yield on 5-year government bonds was 1.527%, rising by about 1 basis point. The Japanese Ministry of Finance held meetings with major dealers in November and December, as market participants requested a reduction in the issuance of ultra-long-term government bonds due to limited demand. Although some major dealers at the November meeting suggested increasing the space for issuing 10-year government bonds, the surge in the yield on 10-year government bonds to a near 27-year high may make the Ministry of Finance reluctant to increase the issuance of such maturity government bonds. The yield on Japanese ultra-long-term government bonds has been rising since the end of October, as concerns about Japan's public finances intensified due to Prime Minister Kishida Fumio's economic stimulus plan. On December 16th, the Japanese parliament approved a supplementary budget for the 2025 fiscal year (April 2025 to March 2026) with a massive fiscal expenditure of up to 18.3 trillion yen, claiming to be the largest scale post-pandemic. This budget, aimed at combating price increases and promoting economic growth, will raise 11.7 trillion yen through new government bond issuances. Meanwhile, on Friday, the Japanese government finalized the budget for the 2026 fiscal year at a general accounting total of approximately 122.3092 trillion yen. This exceeds the approximately 115 trillion yen of the 2025 fiscal year, setting a new record high. With high debt levels and the Bank of Japan pushing for interest rate hikes, Japan's expansionary fiscal policy has raised concerns about fiscal sustainability. The Japanese Ministry of Finance previously projected that the yield on 10-year Japanese government bonds would rise to 2.5% by 2028, and interest on debt would increase from 7.9 trillion yen last year to 16.1 trillion yen by 2028. According to the International Monetary Fund (IMF), Japan's total government debt is expected to reach 229.6% of its Gross Domestic Product (GDP) in 2025, ranking the highest among developed countries. It is worth mentioning that the market expects the Bank of Japan to be forced to adopt a more aggressive approach to interest rate hikes due to rising inflation expectations and the pressure of depreciation on the yen, which led to weak demand in the Japanese 2-year government bond auction held on Thursday. The key indicator of demand, the bid-to-cover ratio, was only 3.26, lower than the previous 3.53 and the 12-month average of 3.65. In the future, with an increase in the issuance of 2-year government bonds and ongoing expectations of interest rate hikes by the Bank of Japan due to a structurally weak yen and increased investor sensitivity to monetary policy, the yield on 2-year government bonds may continue to rise.