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Buyers could start to prevail if PM election and cabinet formation offer sense of relief
Long-term and super-long-term JGB yield scenario for October 20-24
The 10-year JGB yield is seen hovering in the 1.60%-1.65% range this week. Key catalysts are likely to include 1) the outcome of the prime ministerial election in Japan, 2) US financial market developments, and 3) speculation regarding a BoJ rate hike.
With respect to the first factor, an extraordinary Diet session is expected to convene on October 21 and elect a prime minister the same day. The deadline for the LDP and the Japan Innovation Party ("Ishin") to form a coalition government is October 20. If they fail to come to an agreement, the three opposition parties may resume discussions, leaving the election outcome uncertain until the very end. However, the JGB curve has already undergone a pronounced bear-steepening since Sanae Takaichi’s victory in the LDP leadership election on October 4.Regardless of who becomes the next prime minister, we suspect the market has already priced in an expansionary fiscal stance for the next administration. Fiscal concerns have been a key market theme since the start of the fiscal year, but there have not been any additional economic packages or supplementary budgets. Whether the next cabinet is led by Ms. Takaichi or someone from the opposition, it is unlikely to enjoy a robust political base, making it difficult to implement highly aggressive fiscal stimulus. Bond selling driven solely by "concerns" has its limits, and we think a sense of relief could prompt buybacks of long- and super-long-term JGBs after a PM is elected and a cabinet is formed.*1
Regarding US financial market developments, concerns over deteriorating earnings and credit risks in the US banking sector intensified after two regional banks disclosed issues related to potentially fraudulent loans on October 16. The10-year UST yield fell below 4% in response, closing under this level for the first time since April 4. If concerns over US credit risks persist this week, downward pressure on the 10-year UST yield could also weigh on its Japanese equivalent. However, we expect the benchmark long-term yields in Japan and the US will rebound if these concerns are quickly dispelled.
With respect to BoJ rate hike speculation, Policy Board member Hajime Takata is scheduled to speak on October 20. Mr. Takata, who voted against leaving rates on hold at the Bank’s September 18-19 Monetary Policy Meeting, is expected to explain his rationale for favoring a rate hike, but we anticipate a muted reaction from the bond market. Board member Naoki Tamura, who also proposed a rate hike at the September MPM, spoke at a meeting of local business leaders on October 16, but the market’s response was subdued. Bond investors have already priced in a rate hike no later than the January MPM but see a rate hike at the October 29-30 meeting as unlikely due to the political calendar. We think Takata’s comments alone are unlikely to prompt the market to reprice an October rate rise.
We project the JGB curve will bull-steepen this week if US credit concerns intensify(second factor above), while it may bull-flatten if, as we expect, concerns about expansionary fiscal policy ease once a cabinet is formed. Meanwhile, a bear-steepening could ensue if (contrary to our expectations) fiscal expansion concerns are rekindled. One risk scenario involves the release of media reports indicating the BoJ will consider a rate hike at the October meeting, which could trigger a sharp bear-flattening of the curve.
*1 The Mainichi reported on October 17 that LDP president Sanae Takaichi was preparing to appoint former Minister of State for Regional Revitalization Satsuki Katayama as a cabinet member if she is elected prime minister. It also said that if Finance Minister Katsunobu Kato does not continue in his role, there is a proposal to appoint Ms. Katayama--who is a member of the Upper House and a former Ministry of Finance official--as his successor.