Japan Economic & Financial Weekly

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JGB yields seen nervously testing the upside with an eye on Trump 2.0

The 10-year JGB yield tests the upside this week with an eye on the key 1.2%threshold. Key drivers include 1) developments in the 10-year UST yield, 2)developments in risk premia (including term premia) ahead of the start to the second Trump administration, and 3) the likelihood of a January BoJ rate hike.

With respect to the first factor, the 10-year UST yield climbs further and pulls the10-year JGB yield with it if the December US payroll report (Jan 10) fuels speculation of an early end to Fed rate cuts with evidence of a strong US economy and rising wages. But if the employment report points to a slowdown in jobcreation, the 10-year yields in both countries pause their recent advances. One concern regarding risk premia is the recent rise in term premia in the UST market(Graph 1). Contributing factors include the lingering issue of the US federal debt ceiling and uncertainty surrounding Trump administration policies. Financial and capital market volatility may pick up ahead of Mr. Trump’s inauguration ceremony on January 20, leading to growing risk aversion in the JGB market as well and putting steepening pressure on the JGB curve at times.

As for the likelihood of a January BoJ rate hike, we will need to closely monitor Deputy Governor Ryozo Himino’s speech on January 14 along with media reports in the lead-up to the January Monetary Policy Meeting. If they contain indications of a January rate hike, rising short- and medium-term JGB yields could push the 10-year JGB yield above 1.2%. However, yields at that level are likely to prompt dip-buying by domestic final investors, thereby preventing a unidirectional rise in yields. And if Mr. Himino suggests the Bank is reluctant to raise rates in January, mounting speculation that a hike will be postponed could spur dip-buying demand and send the 10-year JGB yield lower. We think the latter scenario is more likely. Incidentally, our model for the 10-year JGB yield, which is based on the 10-yearUST yield, the 1-year-forward 1-month OIS rate, and BoJ ownership of JGBs (stock effect), currently generates an estimate of around 1.13% (Table 1), which is a bit lower than actual yields.