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Fiscal expansion concerns ease; focus on policy messages from Powell and Ueda
Long-term and super-long-term JGB yield scenario for October 27-31
The behavior of the 10-year JGB yield this week will depend on the results of the Fed's FOMC meeting on October 28-29 and the BoJ Policy Board meeting on October 29-30. The market consensus is that the Fed will cut rates by another25bp, while the BoJ is expected to leave policy on hold. Even if those forecasts prove accurate, attention will be focused on the messages sent by Fed Chair Jerome Powell and BoJ Governor Kazuo Ueda regarding future policy conduct at their press conferences.
To provide context, Chair Powell noted in a speech and Q&A session at the National Association for Business Economics (NABE) on October 14, prior to the blackout period for the FOMC meeting, that “it is fair to say that the outlook for employment and inflation does not appear to have changed much since our September meeting.... Inflation...appears to be continuing to increase quite gradually...but now the labor market has demonstrated pretty significant downside risks.” This echoed the Fed’s stance at the September policy-setting meeting and suggests a 25bp rate cut designed to address downside risks to employment could be justified. If Mr. Powell emphasizes downside risks to employment at his post-FOMC press conference this week (or fails to do so), that could lead to a decline(or rebound) in the long-term UST yield, which would probably affect the long-term JGB yield.
The market consensus (and our own expectation) is that the BoJ will leave policy on hold. But if there are more dissenting votes at the October meeting -- for instance, if the vote split goes to 6-3 from 7-2 at the September MPM -- it could fuel speculation that more Policy Board members are questioning Governor Ueda’s cautious stance on rate hikes and prompt the 10-year JGB yield to test its recent intraday high of 1.7%. A similar outcome could unfold if the governor, during his press conference, signals an imminent rate hike with remarks such as “confidence in achieving the outlook has increased further” or “we want to see just a little more data.” Conversely, if Mr. Ueda emphasizes downside risks to the economy, saying that “the impact of tariffs is delayed, and caution is warranted regarding potential downside risks to the US and global economies,” expectations for a rate hike by the end of the year may recede, keeping the 10-year yield in the low-to-mid 1.6%range as the market moves into wait-and-see mode.
This week we expect the flattening trend in the super-long sector to continue, although with some volatility. JGB investors worried since this spring about a rising fiscal risk premium triggered by fiscal expansion in the post-Ishiba era now appear to be feeling a temporary sense of relief. There are several reasons for this. First, the LDP’s coalition partner is not the Democratic Party for the People (DPP) but the Japan Innovation Party (“Ishin”). During the recent Upper House election, the DPP campaigned on a platform of increasing take-home pay through policies like reducing the consumption tax rate on all goods and services to 5% until real wages show sustained growth, which sent a strongly expansionary fiscal message. In contrast, Ishin has emphasized the need for thorough (and potentially painful)administrative and fiscal reforms and supports fiscal consolidation via “a radical review of revenues and expenditures.”
Additionally, Ishin’s proposal for eliminating the consumption tax on food and beverages for two years was addressed in the coalition agreement, which said that “legislation will be discussed with a view to exempting food from the consumption tax for two years.” However, the two parties have merely agreed to hold future discussions on the issue at this point. Additionally, former Regional Revitalization Minister Satsuki Katayama was appointed as finance minister. Ms. Katayama, a former official at the Ministry of Finance and the first woman to serve as Budget Bureau Director there, has a close relationship with Prime Minister Sanae Takaichi,whom she endorsed in the LDP leadership election. When then-Prime Minister Fumio Kishida formerly proposed a tax hike to fund increased defense spending, Ms. Katayama expressed her concerns, deeming the move “hasty.” That suggests she may not fall strictly into the fiscal austerity camp. Nonetheless, she understands the importance of maintaining confidence in the nation’s fiscal sustainability and is expected to pay attention to developments in the JGB market.