Japan Economic & Financial Weekly

JGB market outlook for September 7-117-11

The yield on the newly issued 10-year JGB is expected to hover around 3% this week. Investors are likely to remain in wait-and-see mode ahead of the FOMC and BoJ Policy Board meetings next week. The 10-year yield could rise in nervous trading depending on external developments. For instance, further increases in crude oil prices amid sustained turmoil in the Middle East, or a decline in the yen vs. the euro if the market takes a hawkish view of the outcome of the ECB Governing Council meeting on September 9-10, would probably lift the 10-yearJGB yield via higher inflation expectations. But even if the yen weakens, concerns about official currency intervention are likely to prevent USD/JPY from rising above160 or so, which means the advance in the 10-year yield is also likely to pause. The 2-year-forward 1-month OIS rate (and the 2-year-forward 1-year rate) is regarded as a gauge of market expectations for the terminal rate, and as it approaches the 2.5% upper bound of BoJ estimates of the neutral rate, the sense of a near-term overshoot will probably cap further increases in the 10-year yield. The market already sees a near-100% probability of a rate hike at the September Monetary Policy Meeting. The belief that pricing in a 50bp hike or back-to-back increases would be going too far may also serve to check the rise in the 10-yearyield.

The 10-year JGB yield and terminal rate expectations have historically exhibited a strong correlation (Graph 1). Expectations of the terminal rate have recently climbed to around 2.4%, accompanied by an increase in the 10-year yield to around 3%. Since BoJ estimates of the neutral rate range from 1.1% to 2.5%, we think further upside for both terminal rate expectations and the 10-year yield would be limited if the market expects rate hikes to stay within this range. Conversely, if investors expect rate hikes to take the policy rate into restrictive territory, expectations of the terminal rate would probably exceed 2.5%, and the 10-yearyield might break above the area around 3%. While we do not currently expect the policy rate to move into clearly restrictive terrain, we think that for now the market is likely to remain on a knife-edge over whether policy will stay neutral or turn restrictive.

September forecast range (intraday basis):

10-year JGB yield: 2.860%–3.010%

30-year JGB yield: 3.950%–4.150%