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JGB yields may reverse higher on hopes of US trade deal and fears of deteriorating supply/demand
Long-term and super-long-term JGB yield scenario for May 12-16
We expect the 10-year JGB yield to reverse higher this week. The market has already priced in reduced speculation of an early BoJ rate hike, and we see few additional factors that might push yields lower. Meanwhile, there are a number of catalysts that could potentially lift yields or keep them from falling. First, the weak results of last week’s 10-year JGB offering and fears of deteriorating supply/demand in the super-long sector are likely to persist this week. If the 30-year offering on May 13 ends with weakish or poor results, we think the yield curve would experience further bear steepening pressure, sending the 10-year yield higher as well. Speculation about the BoJ’s interim review of the cuts to its bond purchases at the June 16-17 Monetary Policy Meeting is also likely to prevent the 10-yearyield from falling, since some market participants support a step up in the pace of the reductions to restore JGB market functioning.
The announcement on May 8 that the Trump administration had reached a bilateral trade agreement with the UK is likely to fuel expectations of progress in the US trade talks with both Japan and China and may send financial markets back into "risk-on" mode. Although President Donald Trump says the US will not offer other countries the same kind of low-tariff import quota deal for automobiles that it signed with the UK, market participants might well entertain hopes of a scenario in which sector-specific tariffs come up for discussion at the US-Japan trade talks. In that case, we think BoJ rate hike speculation would be rekindled to some extent on the back of "risk-on" appreciation of the dollar against the yen and expectations that the tariffs would not have as large an economic impact on Japan as had initially been feared.
Another factor of concern is the outcome of the consumption tax debate ahead of the Upper House election this summer. On April 25, Constitutional Democratic Party (CDP) leader Yoshihiko Noda indicated the party would seek to eliminate the consumption tax on food products for one year. Mr. Noda claims the party will find ways to fund the tax cut, but the fact that this champion of fiscal discipline has agreed to incorporate a consumption tax cut (even if limited and temporary) in the party’s campaign platform tells us much about the current atmosphere in Nagatacho. Meanwhile, the Yomiuri reported on May 9 that the government and LDP had firmed up their intention not to seek a reduction of the consumption tax as a means of cushioning the blow of rising prices and the US tariffs. While this news should help ease concerns of increased fiscal stimulus, concerns remain given the Ishiba cabinet’s public support ratings, which are still in the 30% range.
