Japan Economic & Financial Weekly

Long-term and super-long-term JGB yield scenario for June

We expect long-term interest rates to fall back in June as global inflation concerns ease before finding support on concerns about the Takaichi administration possibly taking an expansionary fiscal policy. A rate hike at the June 15-16 BoJ meeting has already been priced in to a considerable extent, and if the Bank does raise rates we expect the market impact to be limited (we anticipate a 25bp rate hike, which would take the policy rate to 1.00%). A decision to leave policy on hold would be a "dovish surprise,” and concerns about the BoJ falling behind the curve would likely put steepening pressure on the JGB curve, possibly in the form of a twist steepening. If the government were to exercise its right to request a postponement of the vote1on Governor Kazuo Ueda’s rate hike proposal (which would be the second time that had happened since the new Bank of Japan Act came into effect),the market would likely view this as setting a high bar for future rate hikes, leading to a steepening of the curve.

On May 28 (US time), WTI crude oil futures fell below USD90 per barrel and long-term UST yields also declined following a report that the US and Iran had reached a provisional agreement to extend the ceasefire by 60 days, pending approval by President Donald Trump (Axios). According to the same media outlet, the memorandum included a commitment by the Iranian side to remove all mines within 30 days, reopen the Strait of Hormuz, and pledge not to pursue the development of nuclear weapons. During the 60-day negotiation period, the parties would also discuss matters such as the disposal of highly enriched uranium and the lifting of US economic sanctions. Approval by President Trump had yet to be confirmed at the time of this writing, but concrete progress toward ending the fighting would help ease concerns over an extended period of high crude oil prices. Although the negotiations are likely to experience further twists and turns, we expect moves toward re-establishing normal operations in the Strait of Hormuz to drive long-term bond yields lower by reducing the risk premium associated with inflation uncertainty.

On the other hand, we think the outlook for the Takaichi administration’s fiscal policy will help to curb any decline in the 10-year JGB yield. Ms. Takaichi is expected to make a final decision as soon as late June on the two-year consumption tax exemption for food and beverages that she pledged in the latest Lower House election. Kyodo News reported on May 25 that a proposal to set the tax rate at 1%, rather than zero, has become the prevailing view within the government, and that the prime minister intends to promptly submit related bills tothe Diet and seek their enactment. Lowering the tax rate on food and beverages to1% would cost about JPY4.3 trillion in foregone revenues. Attention will focus on the prime minister’s statements regarding the timing of the tax cut and how it will be funded.

The market will also be closely watching the blueprint for the Takaichi cabinet’s first "Basic Policy on Economic and Fiscal Management and Reform.” Along with information on the consumption tax cut, the prime minister is expected to provide some indications of the outlook for the government’s growth strategy and refundable tax credit and its shift away from single-year budgeting. It appears that the policy blueprint will be finalized in July (Nikkei, May 23). This is where “bridging bonds” come into play. Reuters reported on May 28 that the government has decided to use “bridging bonds” to provide partial funding for Prime Minister Takaichi’s growth strategy and crisis-management investments and is expected to declare this explicitly in the Basic Policy blueprint to be formulated this summer.

“Bridging bonds” are a means of covering temporary funding shortfalls and areissued only after securing funding for their eventual redemption (Table 1).Nevertheless, they still result in a temporary increase in JGB issuance. Additionally, some of the funding sources specified for the special bonds recently issued to fund childcare programs are less than concrete (e.g., “via extensive expenditure reforms, including reductions in medical costs through digitalization).” We think considerable attention is likely to focus on the reliability of the funding sources indicated along with the scale of issuance in FY27.