To read the full report, please download PDF.
Elevated Middle East tensions complicate super-long JGB supply/demand picture ahead of Upper House election
Long-term and super-long-term JGB yield scenario for June 23-27
We see the 10-year JGB yield trading with a downward bias but with limited downside this week. A sense of reassurance now that the June Monetary Policy Meeting is over, coupled with revisions to the MoF’s debt issuance plans for FY25,should help curb any rise in yields. As for the former, BoJ Governor Kazuo Ueda indicated at his press conference after the June MPM that he wanted to confirm the economic impact of the US tariffs in the hard data before making any decisions. This suggests there is little likelihood of additional rate hikes, at least in the near term, and should help to discourage speculation of further rate increases. With respect to the JGB issuance plans, a number of news reports have already outlined the proposed changes. We expect that reduced issuance of super-long JGBs and the decision not to increase supply of 5-year bonds will check upward pressure on yields not only in the super-long and 5-year sectors but also in the 10-year sector.
In any case, we do not think the BoJ has abandoned its rate hike scenario, and an Upper House election awaits next month, with voters expected to go to the polls on July 20. As for the possibility of future rate hikes, the 2-year-forward 1-month TONAOIS rate -- which is often referenced as an indicator of market expectations of the terminal rate -- has been holding steady around 0.9% and appears to be resisting further declines. With regard to the election, if the market continues to contemplate a potential ouster of the Ishiba administration with its emphasis on fiscal discipline, that could weigh especially heavily on super-long JGBs.
The escalation of tensions in the Middle East could also act as a destabilizing influence. The market initially reacted to Israel’s attack on Iran by moving into "risk-off" mode and pushing bond yields lower, but the impact is unlikely to be unidirectional. An extended period of elevated oil prices could put upward pressure on the 10-year JGB yield via higher inflation expectations. An impact via fiscal policy is also conceivable. When the leaders of various political parties met on June 19, Prime Minister Shigeru Ishiba announced his intention to implement additional measures on June 26 to ease the impact of a sharp rise in gasoline prices due to Middle East tensions. No additional JGB issuance is expected since the government will reportedly utilize surplus funds, but caution is warranted in as much as the market is likely to be sensitive to fiscal policy developments ahead of the Upper House election next month.
