Japan Economic & Financial Weekly

JGB market outlook for October

We expect the 10-year JGB yield to remain elevated and trade with an upward bias in October. With respect to monetary policy, concerns are likely to persist that the BoJ will be too slow to tighten. We anticipate another 25bp rate hike from the Fed on October 28 and assume that markets will gradually price this in. If the 10-yearUST yield declines as concerns over US inflation ease, that would also help stem the rise in the 10-year JGB yield. However, we expect the BoJ to hold at the October 29-30 Monetary Policy Meeting, which comes immediately after the FOMC meeting, in line with the latest market consensus. Accordingly, lingering concerns that the BoJ has fallen behind the curve are likely to limit any decline in the 10-yearJGB yield even if the 10-year UST yield moves lower.

In this environment, fiscal policy will hold the key to market developments. PrimeMinister Sanae Takaichi will deliver her policy speech when the extraordinary Dietsession is convened on October 5 (it will run through December 12). The Nikkeireported on September 30 that she plans to emphasize that “we will assess theimpact and respond nimbly if the economy or markets deviate from expectations”and explain her policy of determining annual JGB issuance based ondevelopments in interest rates and other factors. In an exclusive interview with Nippon TV on October 1, the prime minister stressed that “responsible proactive fiscal policy” would “never adversely affect people’s lives in the future” (media quotations translated by MUMSS). With the Trump administration repeatedly expressing concerns over Japan’s fiscal and monetary policies, the government appears to be under pressure to secure the market’s trust. The run-up to the finalization of the FY27 government budget proposal and JGB issuance plan in mid-December is likely to be a critical test of whether “responsible proactive fiscal policy” can gain the market’s confidence and help stabilize the yen and the 10-yearJGB yield.

In this regard, debate over the consumption tax cut bill will be a key focus inOctober. Various reports suggest the bill is likely to be submitted in mid-October.The key issue is funding. The government had stated it would secure the JPY10trillion or so needed for the two-year tax cut via a comprehensive review ofrevenues and expenditures, without relying on special deficit-financing bonds, but ithas yet to submit any concrete proposals. Unless a funding proposal acceptable tomarket participants can be presented, concerns about a worsening fiscal positioncould put upward pressure on the 10-year JGB yield. Conversely, theannouncement of permanent and effective funding measures would likely send the10-year yield lower. Finance Minister Satsuki Katayama also announced onOctober 1 that a meeting of vice-ministers from the relevant ministries andagencies would be held on October 9 to discuss the “Japanese DOGE” initiative tocut government subsidies and funds deemed insufficiently effective. Ms. Katayama expressed her determination to proceed with this initiative, saying “It isunacceptable for money transferred from the general account to simply sit idle infunds. The tough negotiations with the ministries starts now” (translated byMUMSS). We will be watching to see how large a challenge she can mount to the vested interests of individual ministries and agencies.

Renewed concerns that the BoJ has fallen behind the curve have had an impact on the JGB yield curve. These worries have been the main driver of higher yieldssince the Takaichi administration took office, particularly in the 10-year sector.However, they eased following the coordinated yen-buying intervention by Japanand the US in late July, leading to a tightening of the 2s10s JGB spread. Thetightening move ended after two Policy Board members opposed the rate hike atthe September MPM and government representatives made comments in theSummary of Opinions urging caution on further rate hikes. The 2-year-forward 1-month TONA OIS rate, considered a gauge of terminal rate expectations, alsobriefly topped 2.5%, the upper bound of the BoJ’s estimated range for the neutralrate of interest (Graph 1). Markets appear to be assessing whether the policy ratewill remain within the neutral range or move into clearly restrictive territory. In thissense, the BoJ’s messaging at the October MPM will be an important indicator ofthe outlook for the 10-year JGB yield.

Meanwhile, market concerns about fiscal policy appear relatively subdued at present. Asset swap (ASW) spreads, which are thought to reflect fiscal (credit) risk and JGB liquidity risk, are below their levels at the start of the fiscal year in all of the key maturities (Graph 13). They are also tight relative to spreads in other major economies. That said, this situation could change. If developments in the consumption tax cut debate raise questions about the government’s commitment to fiscal discipline, that would be conducive to a widening of ASW spreads and a rise in long- and super-long-term JGB yields.

Forecast range (intraday basis):

10-year JGB yield: 2.900%–3.300%

30-year JGB yield: 4.000%–4.450%