Japan Economic & Financial Weekly

Long-term and super-long-term JGB yield scenario for July 27-31

JGBs are likely to be volatile in the week of July 27 with an upward bias to yields. The 10-year JGB yield, which rose as high as 2.9% in intraday trading on July 9,fell back below 2.7% after Finance Minister Satsuki Katayama mentioned a possible review of the Government Pension Investment Fund’s policy asset mix on July 10. However, it worked its way gradually higher last week, climbing above2.8% in intraday trading on July 24. In addition to a weak yen and higher crude oil prices driven by renewed tensions in the Middle East, expectations of an early rate hike by the Bank of Japan also put upward pressure on yields. The Basic Policy approved by the Takaichi cabinet on July 21 contained no surprises, but it also gave no indication of the scale of expenditures or JGB issuance under the FY27budget. A decision on the consumption tax cut for food items was also deferred until early August, leaving uncertainty over the fiscal policy outlook unresolved. With a review of the GPIF’s asset mix unlikely to lead to any immediate conclusions, the initial sense of surprise that prompted expectations of improved JGB supply/demand is fading.

Against this backdrop, the JGB market is likely to focus its attention on higher crude oil prices and upside risks to inflation. The pro-Iran Houthi militant group in Yemen announced a maritime blockade of Saudi Arabia on July 20, and on July 23it said it had attacked two Saudi Arabian oil tankers near the Bab el-Mandeb Straitin the Red Sea. This has raised concerns over a “dual blockade” of the Strait of Hormuz and the Red Sea, which serves as an alternative route. President Donald Trump told US news website Axios on July 23 that “I am considering a massive attack [on Iran]. Bigger than ever before” and that “I am close to making a decision. We are all set for it.” If this week brings signs of a resumption of talks between the US and Iran, inflation concerns would probably fade, pushing JGB yields lower. Conversely, the commencement of a full-scale US military attack would likely drive yields higher.

The FOMC meeting on July 28-29 and Fed Chair Kevin Warsh’s post-meeting press conference will also warrant close attention. In his congressional testimony on July 14-15, Chair Warsh pledged to achieve price stability but did not explicitly address the interest rate outlook or the possibility of rate hikes. As US inflation has exceeded the 2% target for more than five years, Mr. Warsh needs to continue emphasizing his commitment to price stability in order to maintain credibility. But he will also have to explain that this does not necessarily mean a rate hike is imminent. Regarding the latter factor in particular, attention will focus on the FOMC’s discussion of whether rising prices in specific sectors, such as the war-driven increase in energy costs—an area beyond the Fed’s influence—could spread to a wider range of sectors. If the chair unexpectedly adopts a hawkish to neat his press conference, market expectations of a Fed rate hike by year-end would pick up, sending the 10-year UST yield higher and potentially lifting the 10-yearJGB yield.

As the outcome of the BoJ’s Monetary Policy Meeting will be announced on Friday, July 31, the market is unlikely to fully digest it until next week. But if the yen continues to weaken this week, expectations of an early rate hike would make itdifficult for investors to buy the short- and medium-term sectors. In this context, if heightened tensions in the Middle East, a hawkish Fed, concerns over fiscal expansion under the Takaichi administration, and a falling yen (fueling anticipation of an early BoJ rate hike) were to occur simultaneously, yields could rise more than expected as the curve bear-steepens.