Japan Economic & Financial Weekly

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Concerns about pace of BoJ rate hikes and terminal rate seen weighing on market

Long-term and super-long-term JGB yield scenario for February

The 10-year JGB yield hovers around 1.2% in February. Factors serving to push yields higher include 1) economic data showing firmness in the US economy and inflation, 2) President Donald Trump’s imposition of higher tariffs (which stokes US inflation fears and lift the 10-year UST yield), and 3) speculation that the BoJ will accelerate its rate hikes or raise the terminal rate. The third is likely to have the greatest impact. Although the 10-year UST yield has dropped back below 4.6%from its recent peak, the 10-year JGB yield remains at the elevated level of just over 1.2%. The sharp increase in the Bank’s core CPI inflation projections in the January Outlook Report, coupled with Governor Kazuo Ueda’s comment that there is "still a significant distance to the neutral rate of interest," has sparked concerns about an acceleration of rate hikes and an increase in the terminal rate for this cycle. [February monetary policy] As noted below, we expect the 10-year JGB yield will rise towards the next key threshold of 1.3% if the Summary of Opinions for the January MPM (3 Feb) or the speeches made by Policy Board members on the 6thand 19th of February contain any information supportive of such speculation. Factors likely to push yields lower are the opposite of the three noted above. First, if forthcoming data confirm a slowdown in the US economy or inflation, speculation of a rate cut at the March FOMC meeting is likely to reemerge, sending the 10-yearUST yield lower and putting downward pressure on its Japanese equivalent as well. Second, if President Trump simply uses tariff policy as a negotiating tool and does not actually implement the threatened increases (or sharply limits their application), a fading of US inflation fears and a decline in the 10-year UST yield are likely to curb any upside for the 10-year JGB yield. Finally, if the BoJ continues to argue 1) that there is a wide range of estimates of the neutral rate of interest, making it difficult to pinpoint this rate, 2) that the frequency and pace of rate hikes will depend on future developments in economic activity, prices, and financial conditions, and 3) that conditions in Japan are not such that rates need to be hiked rapidly, we think the 10-year JGB will see some dip-buying. We expect the Fed to lower rates at the March FOMC meeting and also see the BoJ maintaining a gradual approach to rate hikes. As such, the latter (falling yields) is our base line scenario, and the former (rising yields) is a risk scenario.