Intervention risks rise as JGB sell-off extends

JPY: Yen weakness could destabilise JGB market

The big move in Japan’s financial markets today was in the JGB market rather than the yen with the 10-year JGB yield hitting a high of 2.10% before retracing modestly but still up 6bps from Friday’s close and the highest since 1999. The move higher now in December is close to 30bps with investors clearly reducing risk in the aftermath of the BoJ meeting on Friday. The FX reaction on Friday to the BoJ’s decision to hike rates by 25bps to 0.75% clearly illustrated fears over the overly-cautious approach to raising rates in circumstances of still high inflation and additional fiscal stimulus set to support the economy in H1 next year. The MoF have clearly taken note of the potential instability ahead and Finance Minister Katayama on Friday stated that she was “deeply concerned” about the moves in FX and that it would take “appropriate action against excessive moves”. Today, Vice Finance Minister for International Affairs, Atsushi Mimura spoke and repeated the “deeply concerned” comments adding that there has been “one-sided, sudden” moves in the foreign exchange market. On Friday, USD/JPY briefly lurched lower following Katayama’s comments before rebounding quickly while today Mimura’s comments today have  had little impact although the yen is marginally stronger on the day.

Financial market instability is the greatest risk to the Takaichi government, especially a sustained bout of yen weakness given this would be most likely to hit the approval rating of the government, which remains high following the leadership election of Takaichi. The 5yr and 10yr area of the JGB curve has suffered worst today with fears over supply to finance the large fiscal stimulus being focused in that area of the curve. The government is also set to approve the fiscal year 2026 budget and investors fear budget details could confirm larger than usual departmental spending. Requests have already been made by government departments and those requests are rarely met with actual spending lower but there has been fears the government may appease to a greater degree government department spending requests.

That could spark further longer-end JGB selling that could in turn reinforce yen weakness, leading to increased speculation of BoJ raising rates more quickly and destabilising the JGB market further. What investors want to see is an acknowledgement from the government that they are aware of these risks and hence will act more cautiously on fiscal policy. In that regard, the FY 2026 budget announcement and approval on Friday is more important than usual.

Given these current risks and uncertainties, FX intervention is very unlikely to succeed without that indication from the government on managing fiscal policy risks appropriately. If that isn’t revealed in Friday’s budget announcement, JGB selling could extend along with another lurch lower for the yen. The MoF could then be forced to intervene although the success of that would be in some doubt.

2S10S JGB SPREAD BREAKS HIGHER SIGNALLING RISKS OF FURTHER YEN DEPRECIATION AHEAD

Source: Bloomberg, Macrobond & MUFG GMR

G10 FX: 2026 Outlook Published  

On Friday, we published our G10 FX Outlook for 2026 FX Focus piece (here) outlining our key forecasts for next year and the primary assumptions that lay behind the forecasts.  

The key takeaway to highlight here is that we expect another year of dollar depreciation but on a scale more modest than this year. The dollar is heading for a drop of around 9% if we stabilise and close around current levels at the end of the month and that would be the largest drop since 2017 – Trump’s first year of his first terms in office. That 2017 drop was more of a one-off given the Fed was actually tightening policy and the US economy (labour market for sure) was more robust than today. Hence, the drop for the dollar this year is unlikely to be a one-off with scope for further gains ahead. We essentially believe the US dollar has peaked and we are now in a multi-year downtrend for the dollar.

We expect the DXY drop to be in the region of around 5% next year which would be consistent with our EUR/USD forecast of 1.2400. The relative yield spread should certainly be supportive of that move given we assume three to four Fed rate cuts and no rate changes from the ECB. While the ECB assumption is already priced, our Fed view is not. Further labour market weakness will be crucial for our Fed assumption to materialise but given the 3mth and 6mth NFP averages (44k and 17k respectively) are below the Fed’s assumption of a 60k over-report of employment, we are already in a scenario of the US economy shedding jobs.

Another aspect highlighted is our view that central bank demand for the euro is set to pick up and will act as an important source of EUR appreciation. Assuming appetite for reducing dollar reserves persists (we think it will), the euro is now better placed to take increased holdings. Sovereign bond supplies will pick up in Europe and of course negative yields are now a thing of the past. EU bond supply will also increase further. The EUR 90bn loan deal agreed for Ukraine last week will help improve liquidity and draw central bank demand over time.

Please see the full publication for lots more detail.

We would like to wish all our readers a Happy Holiday / Festive period. Our next FX Daily Snapshot will be published in 31^st December.

PEAK DOLLAR IS BEHIND US – WE SEE FURTHER DEPRECIATION IN 2026

Source: Macrobond, Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com