Japan Economic & Financial Weekly

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JGB market seen reacting nervously to election results with one eye on BoJ

The 10-year JGB yield fluctuates nervously through the end of November in response to A) the results of the Lower House election in Japan on October 27, B)the outcome of the US presidential election on November 5, and C) speculation regarding the timing of the BoJ's next rate hike. B is likely to have the greatest short-term impact on the yen rates market, followed by A and then C. However, it should be noted that the impacts of these three factors will also interact via developments in financial and capital markets. In such an environment, we expect market participants to sell long- and super-long-term JGBs into strength if the 10-year yield drops below 0.9% and buy them on dips if the 10-year yield approaches the high level of 1.1% posted in 1H FY24.

With respect to the Japanese election, domestic political turmoil and rising uncertainty will have a negative impact on economic activity and make it more difficult for BoJ to hike rates, giving bond yields a downward bias. However, if "sell Japan" sentiment and the "Trump trade" rekindle the upside risks to prices through yen depreciation, the decline in yields may halt because the BoJ will no longer have as much time as it currently does to make a policy decision. And if the ruling coalition and opposition parties both adopt a more accommodative fiscal policy stance ahead of the Upper House election next July, bond investors will start to worry about an increased fiscal risk premium, putting upward pressure on long-and super-long-term JGB yields. On the other hand, we anticipate almost no market impact in the event the LDP-Komeito coalition is able to retain its majority in the Lower House (by offering to bring victorious but scandal-tainted law makers back into the fold, if necessary).

The US presidential race (B) is proving to be as close as expected, and it is also unclear when a winner will be declared. If Republican candidate and former President Donald Trump wins, the so-called Trump trade will persist as investors worry about a resurgence of inflation. If the yen's decline continues and USD/JPY approaches 160, speculation of a December BoJ rate hike will pick up, pushing JGB yields higher. Meanwhile, if Democratic candidate and current Vice President Kamala Harris triumphs, the Trump trade will be unwound and the market's attention will shift back to US fundamentals, resulting in rangebound trading for JGB yields.

Speculation about the timing of the next BoJ rate hike (C) will be influenced by exchange rate developments in response to the results of the two elections (A andB). Market expectations of a December rate hike will pick up if the yen weakens and fade if it strengthens. Like market participants, the Bank will be closely monitoring the outcomes and implications of political events in the US and Japan. After the elections are over, the BoJ will engage in a careful dialogue with the market regarding the next rate hike if the likelihood of a soft landing for the US increases and financial and capital markets stabilize.