Japan Economic & Financial Weekly

Long-term and super-long-term JGB yield scenario for May 18-22

We anticipate volatile action in the JGB market during the week. If concerns over an extended period of high oil prices and worries about inflation driven by a weak yen intensify further, the JGB curve is likely to come under additional bear steepening pressure. Meanwhile, the upward pressure on yields could ease temporarily if momentum builds for a resumption of ceasefire negotiations between the US and Iran. On the domestic front, speculation that the Takaichi cabinet will compile a supplementary budget along with the likelihood that fiscal expansion concerns will persist until the government releases its Basic Policy in June mean JGB yields will probably remain elevated for some time.

At the time this article was being written (1pm on May 15), the on-the-run 10-yearJGB was trading to yield 2.720% (up 9bp from the previous day), according to QUICK. Amid sustained high oil prices, long-term US rates are rising, and dollar buying / yen selling sentiment has re-emerged in the FX market. Reports on May14 that the government is considering compiling a supplementary budget also contributed to the rise in bond yields. The domestic corporate goods price index for April, released on the morning of May 15, was up 4.9% YoY, beating the Bloomberg-compiled market consensus of a 3.0% gain. As the BoJ noted in the April Outlook Report, “it is necessary to pay due attention, in particular, to keep the risk of inflation significantly deviating upward from materializing and there by exerting an adverse impact on the economy afterward, given factors such as underlying CPI inflation approaching 2% and firms’ behavior shifting more toward raising wages and prices.” The Bank appears to be leaning in favor of a rate hike at its June 15-16 meeting (see “BoJ watch” below). However, we wonder whether a rate hike one month from now will be enough in this increasingly volatile price environment.

Former BoJ Governor Masaaki Shirakawa (currently a visiting professor at Aoyama Gakuin University) states in his latest book, Imprinting Currency with Credibility: Ten Proposals from a Central Banker(Nikkei, in Japanese), that “When inflation occurs, not only does the overall rate of increase in prices rise, but it also tends to become more volatile” and that “Lenders not only demand higher interest rates in response to higher (average) inflation expectations but also start to demand a premium sufficient to compensate for the uncertainty of inflation.”We find it difficult to view the recent rise in JGB yields as a desirable increase in response to recent gains in the stock market. It may instead be the result of investors requiring a larger inflation risk premium. To keep risk premia in check, we think policy authorities such as the government and the BoJ will need to squarely address inflation risks and demonstrate a commitment to longer-term inflation stability, even if it involves some short-term pain. Although this is not limited to Japan, risk premia could also expand if the market perceives a strained relationship between the government and the central bank. We think the rise in the 10-year JGB yield would be curbed in either of the following cases: 1) resolution of the root cause of inflation uncertainty (i.e., an easing of Middle East tensions), or 2) action by policy authorities to suppress inflation.