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10-year JGB yield likely to remain elevated amid political turmoil following “Takaichi shock”
Long-term and super-long-term JGB yield scenario for October 14-17
We expect the 10-year JGB yield will continue to trade in elevated territory thisweek, although it is likely to fluctuate in response to domestic political headlines.We see uncertainty persisting as reports suggest preparations are under way toconvene an extraordinary Diet session and elect a prime minister around October21. Fiscal expansion concerns (i.e., fears of increased government bond issuance)are also likely to linger. Although expectations for a rate hike at the October 29-30Monetary Policy Meeting have faded, we project the market will move increasinglyinto wait-and-see mode as investors seek to gauge the outcome of the meeting.
While the LDP leadership election is finally behind us, the domestic political outlook remains highly uncertain. LDP president Sanae Takaichi met with her Komeitocounterpart Tetsuo Saito on October 7, but the two were unable to reach anagreement on preserving the coalition. On the same day, Democratic Party for thePeople (DPP) leader Yuichiro Tamaki said he wanted to see the two parties confirmtheir alliance before entering into talks on his own party’s potential participation.Ms. Takaichi and Mr. Saito are scheduled to meet again on the afternoon ofOctober 10. We think the political situation would grow even more chaotic ifKomeito decided to exit the coalition.
Below we present four broad short-term political scenarios. Note that these do not represent our predictions.
Scenario A: LDP, Komeito, and DPP form a coalition government. This was our baseline scenario immediately after the LDP election. The coalition would enjoy a majority in both houses of the Diet, promising greater stability than the minority Ishiba cabinet. Here the conditions set by the DPP for joining would need to be closely watched. If its demands are limited to raising the tax-free income allowance and lowering the provisional gasoline tax, the fiscal impact would be limited, and concerns about fiscal expansion would probably fade. However, fiscal concerns would likely intensify if the DPP demanded that the consumption tax rate be cut to5% (until real wages start growing).
Scenario B: LDP and Komeito maintain existing minority coalition. As with the Ishiba cabinet, the government would have to engage in negotiations with opposition parties to pass any legislation. The public approval ratings of the Takaichi administration would be critical in this case. High approval ratings would give the coalition the leverage it needs to negotiate from a position of strength. Conversely, low approval ratings would complicate talks with the opposition.
Scenario C: LDP and DPP form minority coalition government. A coalition between the LDP (which has 196 seats in the Lower House) and the DPP (with 27 seats)would fall short of a majority in the Lower House, reducing the likelihood of this outcome. However, it warrants some attention since the LDP and the DPP might seek to implement aggressive fiscal stimulus with the next general election in mind.
Scenario D: Opposition unites to bring about regime change. In this tail-risk scenario, Komeito exits the coalition and an opposition party leader is electedprime minister, with the LDP falling from power. Here as well, however, the coalition would probably be a minority government with questionable stability.