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JGB yields may test upside with eye on outcome of Upper House election
Long-term and super-long-term JGB yield scenario for July 14-18
We expect the 10-year JGB yield will trade with an upward bias again this week. Since the start of FY25, JGB yields have been pulled in one direction by fading speculation of BoJ rate hikes and in the other by worries about expansionary fiscal policy. However, the latter factor is likely to prevail as the July 20 Upper House election approaches. Fiscal concerns may ease if campaign reports early this week indicate the ruling coalition is more likely to maintain its majority, thus prompting buybacks in the super-long sector and pushing the 10-year yield lower. Conversely, if news reports suggest an increased likelihood of the coalition losing its majority, the opposite effect is likely.
We think the market has already priced in the latter (risk) scenario to some extent. Even if the coalition falls short of a majority, it does not mean that a consumption tax cut will follow immediately. The LDP-Komeito coalition has lost its majority in the Lower House, but the LDP remains by far the largest party in terms of seats held and is likely to remain the biggest party in the Upper House as well. Moreover, the opposition parties are divided in their views on the implementation and funding of a consumption tax cut (Table 1). Actually lowering the consumption tax would require amendments to existing legislation, and it is hard to envision the ruling and opposition parties coming quickly to a consensus on such changes. This creates a substantial hurdle to a tax cut. As such, we see little likelihood of a sustained rise in the 10-year JGB yield even if the coalition appears more likely to lose its majority in the upcoming election.
Additionally, we think fading expectations for BoJ rate hikes will indirectly help to cap any rise in the 10-year JGB yield by stabilizing short- to medium-term yields at low levels. In his press conference following the May 1 Outlook Report meeting, Governor Kazuo Ueda explained the Bank’s baseline scenario as follows: "Although our outlook has factored in a certain degree of progress in tariff negotiations, it assumes that a non-negligible level of tariffs will remain." However, the 25% tariff rate for Japan announced by US President Donald Trump on July 7was 1ppt higher than the initially announced 24% tariff, presenting an additional downside risk to Japan’s economy. We expect this will further dampen expectations for an early BoJ rate hike and thereby check any increase in the 10-year JGB yield.
