Japan Economic & Financial Weekly

JGB market outlook for September 14-18

The yield on the on-the-run 10-year JGB is likely to remain volatile during the week of September 14. We think it could break above 3% and test the upside depending on developments in the 10-year UST yield. The focus is on the Fed’s next move after the US release of the August CPI on the evening of September 11 (JST). At the press conference after the July FOMC meeting, Federal Reserve Chair Kevin Warsh outlined his reaction function, stating that, with the labor market “more or less at equilibrium,” the Fed would consider tightening if underlying inflation rises and easing if it declines. At the Jackson Hole symposium on August 28, he further clarified his threshold for action by saying that “We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.” If core CPI inflation in August comes in higher than the consensus forecast of 2.4% YoY, the market will probably view a rate hike at the September 15-16 FOMC meeting as being a near-certainty and begin to lookahead to further increases in the policy rate. However, considerable uncertainty remains over whether Chair Warsh will actually raise rates. For example, if the Fed decides to leave the policy rate on hold despite a stronger core CPI reading, concerns that it is falling behind the curve would likely put bear-steepening pressure on the UST curve. A rate hike would generally be expected to lead to a twist-flattening of the curve, but the discontinuation of forward guidance by Mr. Warsh would probably make it difficult to project the subsequent path of the policy rate. Conversely, if core CPI growth is in line with or below the consensus forecast and the Fed keeps the policy rate on hold, US Treasuries would probably catch abid, particularly in the short- and medium-term sectors. However, the 10-year UST yield is unlikely to decline if higher crude oil prices and concerns over US fiscal expansion persist.1An increase in the 10-year UST yield or a pick-up in global inflation concerns would probably put upward pressure on the 10-year JGB yield this week, while a lower 10-year UST yield or an easing of inflation worries would likely depress the 10-year JGB yield.

At its September 17-18 Monetary Policy Meeting, we expect the BoJ to raise the guidance target for the policy rate (the uncollateralized overnight call rate) from "around 1%” to “around 1.25%.” See the BoJ watch section below for further details on the meeting. As the market has priced in a greater than 90% probability of a rate hike and the decision will be announced ahead of the weekend on Friday afternoon, any additional impact this week is likely to be modest. Some market participants, particularly in the forex market, are expecting the BoJ to carry out rapid and substantial rate hikes. However, we think Governor Kazuo Ueda will limit his press conference remarks to emphasizing the importance of stabilizing underlying inflation at around 2% and reiterating the Bank’s official stance that it will consider the timing and pace of rate hikes while assessing the likelihood that the baseline outlook for economic activity and prices will materialize, along with associated risks. Articles published by Reuters and Jiji Press last week also indicated that the BoJ has no predetermined view regarding the pace of rate hikes or the terminal rate.2Additionally, Bloomberg reported on September 11 that the median estimates for both the terminal rate and the neutral rate of interest in a BoJ survey of 52 economists were only 1.75%. If the 10-year UST yield fails to break above 5% this week, we project the 10-year JGB yield will trade in a range slightly below 3%. If the benchmark long-term US yield exceeds 5%, we expect dip-buyers will emerge once the 10-year JGB yield moves above 3%.

September forecast range (intraday basis):

10-year JGB yield: 2.900%–3.080%

30-year JGB yield: 3.950%–4.150%