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Risk-averse market mood likely to persist on Trump concerns
We anticipate continued volatile trading for the 10-year JGB yield this week. The "tariff shock" unleashed by the Trump administration has led participants in many markets to trim their positions. There are concerns that increased volatility will undermine risk tolerance and drain market liquidity in a vicious cycle of sorts. In the yen rates market, the price-discovery function and liquidity have both suffered due to a sharp widening of asset swap spreads and a surge in yields driven by what appears to be an unwinding of speculative long positions (flatteners) in the super-long sector.
Financial and capital markets also experienced heavy volatility last summer after the release of weak US employment data, but they regained their composure fairly soon in response to a 50bp Fed rate cut in September and a subsequent string of bullish US economic data. The tariff shock, meanwhile, is far more complicated. Since economic activity changes gradually and continuously barring some unpredictable event like a natural disaster or a pandemic, the direction of activity can be predicted to some extent (e.g., the unemployment rate will not drop from10% to 5% in a single month). It is also possible to construct a rational forecast of the channels by which fiscal and monetary policy will influence the economy based on theory and experience.
Politics, however, is a different beast entirely and is characterized by discontinuous changes. A good example would be President Donald Trump’s decision last week to suspend the reciprocal tariffs he had just unveiled. Since we cannot rule out the possibility of more discontinuous shocks from the US administration, the risk-averse mood in global markets is unlikely to clear anytime soon. News reports claim that Minister in Charge of Economic Revitalization Ryosei Akazawa will meet with Treasury Secretary Scott Bessent in the US this week. Although optimistic pundits may anticipate steady progress in the trade negotiations with the US, no one knows when President Trump will decide to say or do something that throws everything up in the air again. Market participants who have been stung repeatedly are unlikely to let down their guard. The risk-averse mood in the JGB market is likely to persist under these circumstances, resulting in a bull steepening with solid demand for short- and medium-term JGBs.
