Yen Slumps, Bond Yields Surge on Takaichi's $135B Stimulus Push

Japan's new Prime Minister Sanae Takaichi unveiled a $135 billion stimulus package on November 21, marking the first major policy push under her administration. The 21.3 trillion yen package includes 17.7 trillion yen in general account spending, surpassing last year's 13.9 trillion yen, and 2.7 trillion yen in tax cuts. Markets have reacted with concern, as the yen hit a 10-month low and government bond yields surged to record highs amid fears over Japan's growing fiscal burden according to market analysis.

Takaichi, an advocate of expansionary fiscal policy, emphasized the need to address inflation and support struggling consumers. The stimulus includes energy subsidies and measures to lower gasoline taxes, aiming to ease the cost-of-living pressures. Her government has also pushed back the target for achieving a primary budget surplus, signaling a long-term shift toward larger fiscal spending.

The prime minister's agenda aligns with the legacy of former leader Shinzo Abe, who championed aggressive fiscal and monetary easing. Takaichi reiterated her commitment to "responsible and proactive fiscal policy" during a meeting with Bank of Japan (BOJ) Governor Kazuo Ueda, though no explicit policy requests were made. Meanwhile, concerns over Japan's ballooning debt and its impact on economic stability have intensified.

How Markets Reacted

The announcement sent shockwaves through financial markets. Japanese government bond (JGB) yields reached multi-year highs, with the 40-year yield climbing to a record 3.705%. Investors worry that the stimulus will exacerbate Japan's already massive public debt, pushing the debt-to-GDP ratio even higher. The yen weakened past 157 per dollar, raising import costs for a nation reliant on foreign resources.

The bond selloff has complicated the BOJ's policy path. Despite inflation remaining above its 2% target, the central bank has held rates steady at 0.5% since January. Analysts remain divided on whether the BOJ will raise rates in December or January, though market bets increasingly favor a hike. The central bank emphasized the need for a "smooth landing" toward its inflation goal, but the yen's weakness and rising yields suggest growing uncertainty according to market analysts.

The prime minister's economic panel has advised caution on rate hikes, noting that large-scale spending must first boost domestic demand. However, BOJ policymakers, including Governor Ueda, have signaled that a rate hike remains on the table. The central bank emphasized the need to gradually adjust monetary support as inflationary pressures persist. The next policy decision on December 19 could offer clarity, though Takaichi's government has made no public push for delayed tightening.

Diplomatic and Economic Risks

Takaichi's comments on Taiwan have further strained relations with China, Japan's largest trading partner. Her remarks suggesting that Tokyo might intervene militarily in a China-Taiwan conflict sparked an immediate backlash. Beijing summoned Japan's ambassador and advised its citizens against travel and study in Japan, raising concerns over a potential economic backlash. China's travel advisory threatens to hurt Japan's tourism and retail sectors, which heavily rely on Chinese visitors.

The diplomatic fallout comes at a vulnerable time for Japan's economy. GDP contracted in the third quarter of 2025 for the first time in six quarters, and inflation remains elevated. Takaichi's stimulus is intended to counteract these trends, but analysts warn that the package could deepen fiscal vulnerabilities. A weaker yen raises import costs, and government bond yields remain a barometer of investor confidence according to financial analysts.

What Analysts Are Watching

Market observers are closely monitoring how Takaichi's government balances fiscal expansion with long-term debt sustainability. The supplementary budget, expected to be approved by year-end, will likely rely on inflation-driven tax revenue and new bond issuance. However, the size of the bond program remains uncertain, with some estimates suggesting it could exceed 6.69 trillion yen. Analysts are also watching for any sign of policy coordination between the government and BOJ, particularly as inflation pressures persist.

Risks to the Outlook

A key risk for Takaichi's agenda is the potential for a prolonged BOJ rate hike cycle, which could dampen the impact of the fiscal package. Additionally, the China-Japan diplomatic spat threatens to disrupt trade and tourism, which are vital to Japan's recovery. Analysts warn that a full-blown trade conflict could see China impose export restrictions on rare earths or Japanese goods, further straining the economy.

Takaichi's government is also under pressure to address labor shortages and an aging workforce, particularly in sectors like fishing and aquaculture. These structural challenges complicate the path to sustainable growth, even as the stimulus package aims to boost near-term demand. Investors will be watching for signs that the administration can navigate these complex economic and geopolitical risks without further destabilizing markets.