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JGB market probing resolve and policy stance of government and BoJ
Long-term and super-long-term JGB yield scenario for December 8-12
We expect the 10-year JGB yield to trade mostly in the 1.9% range this week as it consolidates just under the key psychological level of 2%. If the government reaffirms its commitment to fiscal discipline and the Bank of Japan communicates its readiness to address the upside risks to inflation, a reduction in risk premia could prompt buybacks in the long- and super-long-term sectors.
The sharp rise in the 10-year bond yield has begun to draw the attention of the Takaichi cabinet. At a press conference held after the cabinet meeting on December 5, Finance Minister Satsuki Katayama said, “We will ensure the sustainability of Japan’s fiscal position to prevent a loss of market confidence” and “we have excellent communication with Governor Ueda.” Her remarks may have been prompted by increased media coverage of the 10-year JGB yield and its proximity to the 2.0% rate on which estimates of debt service costs in the FY25 budget are based.
The MoF’s estimates of the upcoming (FY26) budget’s impact on revenues and expenditures in subsequent fiscal years, published annually in January, assume an interest rate that takes into account implied forward rates (i.e., market expectations of the future path of interest rates). The recent rise in bond yields will therefore have an impact on future fiscal projections. While Prime Minister Sanae Takaichi is unlikely to retract her support for “responsible fiscal stimulus,” we would not be surprised to see messaging from the government aimed at keeping the 10-year JGB yield in check as the work on compiling an FY26 budget begins in earnest.
There is also growing speculation of a higher terminal rate among market participants. This reflects heightened concerns about upside risks to inflation and the possibility that the Bank will fall behind the curve and be forced to tighten policy sharply in response to an uptick in prices. Jiji Press reported on the evening of December 4 that it had learned the BoJ is reviewing its estimates of the neutral rate of interest, the rate that neither stimulates nor holds back the economy. We think the Bank could arrest the rise in forward rates by articulating its thinking on the future path of rates with a view to sustainably and stably achieving the 2% price target. We will be watching for the release of such information or related media speculation ahead of the December 18–19 Monetary Policy Meeting.
This week we expect the yield curve to probe policymakers’ stance. Stronger expressions of government concern about the rising 10-year yield could prompt a bull flattening in the long- and super-long-term sectors, reversing recent moves. An absence of such concern, on the other hand, could rekindle bear flattening pressures. We have updated the “Market Forecast” at the end of this report to reflect our anticipation of a BoJ rate hike this month. Specifically, we have raised our end-December point forecasts for the policy rate, 3-month TIBOR, and the 2-and 5-year JGB yields. No changes have been made to our projections for other maturities or to our forecast ranges for 1Q 2026 and beyond.