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Where will domestic political turmoil lead JGB yields?
Long-term and super-long-term JGB yield scenario for September 8-12
The 10-year JGB yield is expected to be torn this week between expectations that a BoJ rate hike will be delayed due to domestic political turmoil and concerns about fiscal expansion fueled by the same political uncertainty. But on balance, we expect the impact on supply/demand to be positive, keeping yields from rising. The 10-year JGB yield may also test the downside at times if its US equivalent falls further.
The supply/demand environment for newly issued bonds is improving. Despite headwinds from rising US and European bond yields and domestic political turbulence, this week’s 10- and 30-year JGB auctions ended with solid and satisfactory results, respectively. Support came from bond investors buying to restore or maintain their holdings as the end of the first half (September 30)approaches and from expectations that pension funds would rebalance their holdings into bonds. The absence of any super-long JGB offerings this week was also a positive for supply/demand. Additionally, BoJ Deputy Governor Ryozo Himino’s comment on September 2 that "for now we need to pay greater attention to the possibility of a larger impact (from the tariffs)" eased concerns about a surprise rate hike at the upcoming Monetary Policy Meeting on September 18-19.
The domestic political situation remains a key concern. As outlined in the "Key events" section below, the LDP will decide on September 8 whether to hold an early party leadership election. Even if it decides not to proceed with an election, the Ishiba administration is expected to face significant challenges in governing, with many now saying it may eventually be forced to resign. If the LDP decides to hold an early election, Jiji Press has reported that there is a proposal to start campaigning in mid-to-late September, with votes to be cast as early as October 4.There has also been speculation that Prime Minister Shigeru Ishiba might dissolve the Lower House if the party decides to hold a presidential election. 1
It is extremely difficult to predict upcoming political developments, but two points should be kept in mind. First, an extended political vacuum would adversely affect the real economy by delaying the formulation of an economic package. Second, political instability would complicate BoJ decisions on rate hikes. Article 4 of the Bank of Japan Act states, "Recognizing that currency and monetary control are components of overall economic policy, the Bank of Japan shall maintain close contact with the government and ensure sufficient communication to ensure that its policies are aligned with the government’s basic economic policy guidelines. "Without clarity on the form the government will take or the economic policies it will adopt, the BoJ would struggle to engage in meaningful "communication." And with the ruling coalition lacking a majority in both chambers of the Diet, concerns about expansionary fiscal policy—and particularly the consumption tax cut sought by the opposition—will persist whether Ishiba stays on or is replaced. All in all, we think the super-long sector will remain susceptible to steepening pressures.
Yomiuri reported on September 5 that the prime minister had told a number of LDP lawmakers that "although I would prefer not to, I will call a snap election if a leadership election is going to be held."