Testing the limit of fiscal credibility

• The 30-year Japanese Government Bond (JGB) yield moved c.0.3% to a record high of 3.8% this week¹
• This move followed PM Sanae Takaichi’s announcement of a further 5.8% increase in spending²
• Japan’s large cap stock market has outperformed the US, UK and Europe year to date, returning 3.4% at the time of writing¹

Takaichi became Japan’s first female Prime Minister in October last year, assuming responsibility for overseeing the nation’s fiscal policy. Consistent with her campaign pledges, she outlined additional outlays in a supplementary budget toward the end of 2025 and has now proposed a further 5.8% increase in expenditure in the regular 2026 budget, which still awaits approval by the Diet². The magnitude of this expansionary fiscal stance has raised new concerns around the sustainability of government finances, with Japan’s debt-to-GDP ratio the highest among advanced economies at 236.7%³. This has contributed to upward pressure on government bond (JGB) yields. With debt-to-GDP ratios exceeding 100% in the United States, France, Italy, and Canada, Japan’s experience may serve as a cautionary example of how prolonged, seemingly unfunded, fiscal expansion can erode a government’s fiscal credibility and ultimately increase borrowing costs. Japanese Government Bond Yields Source: Capital Economics and London Stock Exchange Group, 2026 Affordability While markets were quick to focus on proposed tax cuts, such as the suspension of the 8% sales tax on food and beverages, we see reassuring evidence suggesting that the sell-off at the long end of the curve may be overstated. Japan’s return to inflation (currently 2.1%³) has supported stronger nominal growth and, in turn, higher tax receipts, which are helping to reduce the debt-to-GDP ratio. JK Investments estimates that this ratio is now declining at a pace of approximately 6% per annum. Moreover, the ownership composition of JGBs provides an additional stabilising force. The Bank of Japan holds approximately 50% of outstanding JGBs, while only around 12% are held outside the region, limiting the scope for sustained bond vigilante pressure. This stands in sharp contrast to US government debt, of which roughly $3 trillion, or about 10%⁴, is held by Europe, and 33.1% is owned by non-domestic investors⁵. Source: JK Investments, December 2025 With interest rates still well below those of other developed economies (currently 0.75%³), Japan is uniquely positioned to borrow at a comparatively low cost and deploy capital into higher-yielding global assets. In addition, the country maintains substantial public and quasi-public asset pools to support its ageing population, alongside the world’s second-largest foreign exchange reserves⁵. As discussed in our previous piece on Japan, these debt dynamics further reinforce the country’s distinctive economic micro-climate and have helped to rekindle investor interest in the region. Bowmore Portfolios We maintain only a negligible allocation to Japanese bonds across both government and corporate issuers, instead favouring UK debt for the majority of our fixed income exposure. Currently, 57.7% of the total fixed income allocation within the Core 5 portfolio is invested in UK assets, a positioning that eliminates currency risk and reflects our expectation of further interest rate cuts this year. Back in October 2025 however, we made a rotation within our Japanese equity exposure, shifting towards a smaller cap, more domestically focused strategy. This allocation was selected to capture the benefits of a broadening corporate governance reform agenda, strengthening wage growth, and a recovering Yen. Since its inclusion in portfolios, the fund has delivered a return of 5.92%. Source: Alpha Terminal, data as at 29/01/2026 The value of your investments can go down as well as up, so you could get back less than you invested. Past performance is not a guide to future performance. Sources: ¹ AM Insights, 29/02/2026 ² Capital Economics, 2026 ³ Trading Economics, 2026 ⁴ Morningstar, 2026 ⁵ JK Investments, 2026 ⁶ Wavemaker, 2021 ⁷ McKinsey & Co, 2017 ⁸ CNBC, 2025 ⁹ Reuters, 2025 ¹⁰ Fortune Business Insights, 2025