Japan Economic & Financial Weekly

JGB market outlook for November 9-13:“Blue Wave” shock tests resilience of2% underlying inflation

We expect JGBs to perform solidly during the week of November 9. If the global equity correction triggered by the “Blue Wave” shock from the US midterm elections persists, a more pronounced flight to quality and expectations of delayed BoJ hikes would probably put downward pressure on yields across the curve. An equity rebound might prompt a bond selloff and push yields higher, but we suspect the move would be limited. Lawmakers and governors elected on pledges to restrict data center construction will naturally seek to deliver on those promises. Equity markets may therefore take some time to complete their repricing. Overseas market participants may also accelerate their position adjustments ahead of the Thanksgiving holiday in the US on November 26.

The Nikkei 225 stood at 57,858 at the close of the morning session on November 6(Friday), down 5.27% on the day. The benchmark 10-year JGB yield briefly fell to2.665%. Amid the global equity selloff, markets were pricing in roughly a 65% probability of a December rate hike by the BoJ as of 11am, down from around 80%the previous day, according to Bloomberg. OIS forward rates have also fallen(Graph 1), with the 2-year-forward 1-month OIS rate trading around 2.06% at the time of writing. Calculations based on the correlation between OIS forward rates and the 10-year JGB yield (Graph 2) suggest that a decline in the 2-year-forward 1-month rate below 2.00% would take the 10-year JGB yield below 2.6%. A decline to 1.75% would imply scope for the 10-year yield to fall to around 2.3%. However, the dollar continues to trade firmly at around JPY157–158 despite the stock market losses. In view of that and lingering uncertainty over the outlook for the Middle East, we see increasingly limited downside for the forward rate, which serves as a proxy for terminal rate expectations.

In the Outlook Report (“The Bank’s View”) published one week ago on October 30,the BoJ concluded that underlying consumer price inflation was “at a level largely consistent with” its 2% price stability target. At his post-meeting press conference, Governor Kazuo Ueda reiterated the importance of “stabilizing underlying inflation at around 2% to prevent the risk of it rising above the price stability target from materializing and subsequently harming the economy” (translation by MUMSS).The full text of the Outlook Report, released on November 2, contained a section(Box 5) titled “Assessing the Degree to Which Underlying CPI Inflation Is Anchored at the 2% Level.” It stated that if underlying inflation is firmly anchored at around2%, “even if an exogenous shock occurs, underlying CPI inflation would be unlikely to rise substantially above or fall substantially below 2%.” Although the full impact of the “Blue Wave” shock on financial markets and the real economy remains to be seen, it may provide the first test of the resilience of 2% underlying inflation in Japan.

Forecast range (intraday basis):

10-year JGB yield: 2.570%–2.750%

30-year JGB yield: 3.720%–3.920%