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Is rise in 10-year JGB yield actually being driven by BoJ rate hike speculation?
The 10-year JGB yield sees volatile trading this week, with the market undergoing big swings as the end of the fiscal year approaches. In the US, there is mounting concern about a stagflation scenario characterized by a slowing economy and resurgent inflation. The 10-year UST yield heads lower if the February US payroll report, due out on the evening of March 7 (JST), offers evidence of a cooling economy. However, we cannot rule out the risk of the Trump administration’s tariff policies lifting inflation expectations among US businesses and households (even if only temporarily), and in fact there are signs that this is already happening. That could delay a resumption of rate cuts by making it more difficult for the Fed to plot a safe course between the opposing cliffs of unemployment and inflation (we anticipate 25bp rate cuts in June, September, and December 2025).
In addition, there are still concerns about the outlook for the 10-year Bund yield after its precipitous rise last week. An increase in Europe’s defense-related spending seems inevitable given the ongoing structural changes in the global political environment. Some argue the same can be said of Japan. Trump 2.0 is accelerating the reversal of the "peace dividend" brought about by the end of the Cold War. If the global economy begins to reverse course, the major economies will need to prepare for deteriorating fiscal positions, declining productivity, and a corresponding pick-up in inflation. While investors should not become overly pessimistic, financial and capital markets are probably pricing in this kind of risk scenario. Widening asset swap spreads in the leading economies (reflecting an underperformance of government bonds) appear to reflect a growing fiscal risk premium.
The recent advance of the 10-year JGB yield also seems to be driven fundamentally by investors factoring in various risk premia. Media reports have attributed the higher yields to mounting expectations of BoJ rate hikes. However, OIS market expectations of future rate increases have been trending sideways (Graph 1), casting doubt on this explanation. To be sure, more companies are indicating a willingness to continue raising wages and prices, and there is a sense that the spring labor offensive will produce larger pay hikes than it did last year. However, this was all expected when the BoJ decided to raise rates at the January Monetary Policy Meeting and should come as no surprise (we forecast the next rate hike will come at the July MPM).
We think the advance of the 10-year JGB yield accelerated last week because of mounting risk aversion in an environment of growing uncertainty. Traditionally investors tended to buy government bonds as a safe asset during "risk-off" markets, but with the current uncertainty being driven by a realignment of the global political and economic structure, we cannot ignore the risk of "bad" inflation. That is why "risk-off" sentiment is unlikely to lead investors to buy government bonds as a haven asset. The possibility of a rise in long-term government bond yields during a "risk-off" market needs to be watched closely.
It is important for investors to remain calm amid market turmoil. Foreigners only own about 10% of outstanding long-term JGBs, which is substantially lower than the ratio for other key economies, and the BoJ holds about 50% of outstanding issuance. Sellers are unlikely to knock the bottom out of the market under these circumstances. If the yen continues to make gains against the dollar, the retreat of "first force" inflation (via import prices) will gather momentum, reducing the upside risks to domestic prices. Although "underlying inflation" is picking up, it has yet to reach 2%, as Deputy Governor Shinichi Uchida noted in his speech on March 5. The ongoing rise in Japanese wages and prices is being driven largely by the supply-side factor of labor shortages. In this sense, we think it is unlikely that the virtuous cycle of wages and prices will stop or that the BoJ’s stance on rate hikes will change significantly as soon as the US imposes additional tariffs on Japanese goods. However, we would be concerned in the event of an increased risk of a hard landing for the US economy or deepening turmoil in financial and capital markets.
We intend to keep a close eye on wage data (which have recently been robust) and consider the potential impact of these big changes in the external environment on the Japanese economic outlook. Turning back to market developments this week, we expect the JGB curve to bear flatten if stocks and the dollar stage a rebound, while a bull/bear steepening is more likely if stock markets and the greenback both post further declines.
