Japan Economic & Financial Weekly

Long-term and super-long-term JGB yield scenario for May 25-29

The rise in JGB yields is likely to pause in the week of May 25, with yields moving sideways. The first half of the week of May 18 saw an abrupt bear steepening ofthe curve, with the newly issued 10-year JGB yield climbing as high as 2.800%(May 18) and the newly issued 30-year JGB trading to yield as much as 4.150%(May 19). As noted in our previous report, this appears to be the result of investors demanding a premium to compensate for inflation uncertainty amid concerns about an extended period of high oil prices. With no exit in sight for the Middle East conflict, it is difficult to envision a sharp and imminent decline in the risk premium.

On the other hand, factors have also emerged that could help prevent further increases in the inflation risk premium. First, the government was reported to be seeking a supplementary budget containing some JPY3 trillion in spending to help the country through a protracted Middle East conflict. It appears that there will beno direct economic stimulus measures, with the budget limited to topping up contingency reserves. In the draft budget, funding is likely to come from additional issuance of special deficit-financing bonds, but we expect the government to avoid an increase in market issuance of coupon-bearing JGBs by drawing down front-loading issuance of refunding bonds and boosting issuance of Treasury bills. Reuters also recently reported that the finance minister is considering expanding JGB offerings for individual investors. We think diversification of the range of JGB investors will help keep the fiscal risk premium in check.

Second, the BoJ appears increasingly likely to raise rates at its next meeting on June 15-16. As discussed in the “BoJ watch” section below, Policy Board member Junko Koeda said in a recent speech that underlying inflation could exceed 2% and concluded that “it is reasonable for the Bank to raise the policy interest rate at an appropriate pace to address high inflation (translated by MUMSS).” US Treasury Secretary Scott Bessent is also reported to support a BoJ rate hike. The OIS market is now pricing in roughly an 80% probability of a June hike. If the BoJ raises the policy rate in view of the upside risks to prices, we think it will help to stabilize long- and super-long-term JGB yields by keeping longer-term inflation expectations in check. The nationwide CPI print for April, released on the morning of May 22,showed the core CPI rising 1.4% YoY, while the core-core CPI was up 1.9%. Both came in below the consensus forecast (+1.7% and +2.2%, respectively, according to a Bloomberg survey). Downward pressure from institutional factors (larger subsidies for private high school tuition, free school lunches, free childcare in Tokyo, etc.) was broadly in line with expectations, but the momentum in food, durable goods, and clothing prices also slowed. Accommodation and other services also came in weaker than expected even though April marked the start of the new fiscal year. While the impact of higher crude oil prices is expected to gradually feed through into downstream prices going forward, the April moderation in CPI inflation should help reassure the bond market.