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Despite ongoing political uncertainties, our breakdown of JPY rates indicate that inflation worries are prevalent. Japan’s Prime Minister Ishiba announced his resignation on 7 September and will remain in place until the leadership election (scheduled on 4 October) concludes. From a rates perspective, the BOJ is viewed to be reluctant to hike rates until there is greater clarity on the next PM. Accordingly, frontend rates see the odds of a BOJ hike crossing 50% only in December’s meeting and close to a full hike priced in January. We think that these odds are underpriced and front-end JPY rates could pop once there is some political clarity in October. Pressures on rates are instead concentrated in the intermediate tenors where a mix of rising inflation expectations and BOJ hikes are reflected.
Weakness in long-end JGBs has also been a key point to watch. Steepening in the JGB curve largely stems from a mix of domestic drivers including sticky inflation, fiscal worries and too-loose monetary policy. In the immediate term, the external backdrop has become more benign for long-end govvies as US Treasury yields focused on slowdown risks. This led to somewhat mixed showing for JGBs as they underperformed peers. In any case, the shape of the curve depends in large part on how aggressive the BOJ is likely to act in the coming few quarters. Assuming a pace of 50bps / year, there would likely be modestly curve flattening. In any case, judging from the reaction of the 40Y yield, some resistance around 3.5-3.6% is appearing.
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