Japan Economic & Financial Weekly

JGB market outlookfor August 17-21

We expect JGBs to be rangebound with an upward bias for the week of August 17.Fading expectations of an early Fed rate hike should be supportive. The US July CPI report, released on August 12, indicated moderate inflation, with the headline CPI rising 0.1% MoM and 3.4% YoY and the core index gaining 0.2% MoM and2.5% YoY. Core services inflation accelerated slightly on a MoM basis to 0.2% from0.0% in June, but the YoY rate slowed to 3.0% from 3.2%. While the inflation outlook remains uncertain given the situation in the Middle East and rising prices for IT goods due to AI investment demand, the latest price data should give not only Fed Chair Kevin Warsh but also the more hawkish FOMC members the room they need to keep policy on hold at the September meeting. We think diminished concerns about US inflation and the stabilization of the 10-year UST yield will help alleviate pressure on the yen and curb further increases in the 10-year JGB yield.

The market is pricing in just under an 80% probability of a BoJ rate hike in September, up from around 65% as of August 7. Rate hike expectations picked up following a series of media reports that boosted the prospects of an early tighteningmove. Bloomberg also reported on August 13 that the government supports an early rate hike to sustain the impact of the coordinated Japan–US foreign exchange intervention, and the Bank of Japan is considering raising the policy rate at the September or October Monetary Policy Meetings. An October rate hike would be regarded as a dovish outcome in view of current market pricing, but the key takeaway from the article is that the government supports an early rate hike. The market’s attention has already shifted to the future pace of rate hikes, which is likely to help stoke investor concerns about an acceleration of tightening. On the other hand, if the Takaichi administration is starting to understand the need for rate hikes, this could help stabilize long- and super-long-term JGB yields by easing concerns that the BoJ has fallen behind the curve.

Fiscal developments warrant caution. Ahead of the end-August deadline for ministries and agencies to submit their FY27 budget requests, speculation of a substantial increase in aggregate requests, combined with uncertainty over how the consumption tax cut will be funded, could fuel concerns about a “malicious” rise in bond yields. Attention will also focus on the cabinet reshuffle and changes to the LDP leadership expected between now and September. Market participants, including overseas investors, are particularly focused on the fate of Finance Minister Satsuki Katayama, who is regarded as a proponent of fiscal discipline within the Takaichi administration. If she is replaced, renewed concerns over fiscal expansion could exacerbate the weakness in the yen and prompt a bear-steepening of the JGB curve, depending on who is chosen to succeed her.

Our outlook for monetary policy is as follows. We expect the BoJ to raise the policy rate to 1.25% in September 2026, 1.50% in January 2027, and 1.75% in June2027. Although the timing of the rate hikes could shift somewhat depending on the external environment, we project the Bank will accelerate the cadence of tightening somewhat now that underlying inflation is approaching 2%. There are two main reasons why we anticipate a terminal rate of 1.75%. First, upside risks to prices are likely to diminish from around mid-2027, due in part to base effects related to this year’s rise in crude oil prices and decline in the yen. Second, our US economy and rates analysts’ baseline scenario calls for US inflation to moderate toward end-2026 and for the Fed to cut rates.2If so, the BoJ’s “adjustments to the degree of monetary accommodation” are also likely to run their course around next summer.

Forecast range (intraday basis):

10-year JGB yield: 2.780%–2.900%

30-year JGB yield: 3.900%–4.080%