Fiscal concerns drive long-term JGB yields higher
In Tokyo trading on May 15 the 10-year JGB yield briefly touched 2.73%, a level last seen 29 years ago in May 1997. The pick-up in long-term interest rates is a global phenomenon, with the sharp increase in crude oil prices stemming from events in the Middle East serving as the primary catalyst.
Rising gasoline prices drove a 3.8% YoY increase in the US consumer price index in April, the largest gain in 35 months, according to data released on May 12. This announcement appears to have given further impetus to the global upswing in long-term rates.
In addition to inflation worries triggered by higher crude oil prices, the surge in JGB yields is probably attributable in part to concerns over the nation’s deteriorating fiscal position and speculation of further rate hikes by the Bank of Japan.
Reports that the government is considering providing subsidies for electricity and gas charges for the July–September quarter (along with the gasoline subsidies introduced in March) and is mulling a supplementary budget to finance such measures have rekindled concerns about the nation’s fiscal position.
Rising gasoline prices drove a 3.8% YoY increase in the US consumer price index in April, the largest gain in 35 months, according to data released on May 12. This announcement appears to have given further impetus to the global upswing in long-term rates.
In addition to inflation worries triggered by higher crude oil prices, the surge in JGB yields is probably attributable in part to concerns over the nation’s deteriorating fiscal position and speculation of further rate hikes by the Bank of Japan.
Reports that the government is considering providing subsidies for electricity and gas charges for the July–September quarter (along with the gasoline subsidies introduced in March) and is mulling a supplementary budget to finance such measures have rekindled concerns about the nation’s fiscal position.
Will government revise its proactive fiscal policy?
These subsidies are provided to all households and therefore place considerable strain on the budget. In my view, the government should consider revising the system by narrowing eligibility and focusing subsidies on low-income households, or alternatively by reducing the subsidies while separately providing cash handouts to low-income households.
While it is necessary for the government to address the heightened tensions in the Middle East and the surge in crude oil prices, it may need to review its overall fiscal policy stance to ensure that such measures do not further damage the nation’s fiscal position and trigger a decline in the yen or an increase in long-term interest rates by undermining market confidence in fiscal discipline.
In the budget for the next fiscal year, for example, the government could signal to the market that it plans to scale back expansionary fiscal measures such as investments in "crisis management," a flagship policy of the Takaichi administration. Another option would be to shelve plans to lower the consumption tax on food products, for which no clear source of funding has been secured.
I suspect the Takaichi cabinet would be unable to ignore an adverse reaction from the financial markets in the form of further weakness in the yen or higher long-term interest rates. Whether the government decides to revise its fiscal policy with an eye on market concerns should be closely monitored going forward.
While it is necessary for the government to address the heightened tensions in the Middle East and the surge in crude oil prices, it may need to review its overall fiscal policy stance to ensure that such measures do not further damage the nation’s fiscal position and trigger a decline in the yen or an increase in long-term interest rates by undermining market confidence in fiscal discipline.
In the budget for the next fiscal year, for example, the government could signal to the market that it plans to scale back expansionary fiscal measures such as investments in "crisis management," a flagship policy of the Takaichi administration. Another option would be to shelve plans to lower the consumption tax on food products, for which no clear source of funding has been secured.
I suspect the Takaichi cabinet would be unable to ignore an adverse reaction from the financial markets in the form of further weakness in the yen or higher long-term interest rates. Whether the government decides to revise its fiscal policy with an eye on market concerns should be closely monitored going forward.
Difficult to curb rise in long-term JGB yields with monetary policy
On May 14, a member of the Bank of Japan's Policy Board who had voted in favor of leaving rates on hold at the Bank's April meeting made remarks in a speech indicating support for an early rate hike. This bolstered expectations for another rate hike and also helped send the 10-year JGB yield higher. The probability of a 25bp rate hike at the June 15–16 BOJ meeting being priced in by financial markets rose to around 78% as a result.
Market participants had been increasingly conscious of the risk of the BOJ falling behind the curve and failing to implement prompt rate hikes, resulting in higher longer-term inflation expectations. But more active rate hike speculation did not lower longer-term inflation expectations, and long-term JGB yields continued to rise. This suggests it may be difficult to curb the rise in long-term yields with monetary policy alone.
There is now a possibility that the Bank will consider revising its balance sheet policy and increasing its JGB purchases, something it had previously been reluctant to do. Whether such actions are ultimately taken is likely to be a key near-term focus for market participants.
Market participants had been increasingly conscious of the risk of the BOJ falling behind the curve and failing to implement prompt rate hikes, resulting in higher longer-term inflation expectations. But more active rate hike speculation did not lower longer-term inflation expectations, and long-term JGB yields continued to rise. This suggests it may be difficult to curb the rise in long-term yields with monetary policy alone.
There is now a possibility that the Bank will consider revising its balance sheet policy and increasing its JGB purchases, something it had previously been reluctant to do. Whether such actions are ultimately taken is likely to be a key near-term focus for market participants.
Sharp correction in stock prices could help keep long-term JGB yields in check
While the BOJ policy rate is still thought to be below the neutral rate for the Japanese economy, the 10-year JGB yield, which has climbed above 2.7%, may already have reached a level with adverse economic effects. Additionally, higher long-term rates may help to curb increases in asset prices, but they also undermine the balance sheets of financial institutions by generating unrealized losses on bond portfolios.
I believe stock prices could decline significantly if more attention starts to focus on these negative aspects of the spike in long-term JGB yields. That, in turn, could cause long-term JGB yields to reverse lower. On May 15, the Nikkei 225 index briefly fell by more than 1,600 points, helping to moderate the rise in long-term JGB yields to some extent. However, it remains unclear whether this state of affairs will continue.
Restoring stability to Japan’s bond market may ultimately require a decline in crude oil prices. Apart from that, I think it is also important for the government to present a policy stance that takes the nation’s finances into account. The fact that US Treasury Secretary Scott Bessent, who visited Japan this week, apparently did not call on the Takaichi administration to pursue a more prudent fiscal policy in view of market concerns, as he had this January, may have been one contributor to the surge in long-term JGB yields on May 15.
I believe stock prices could decline significantly if more attention starts to focus on these negative aspects of the spike in long-term JGB yields. That, in turn, could cause long-term JGB yields to reverse lower. On May 15, the Nikkei 225 index briefly fell by more than 1,600 points, helping to moderate the rise in long-term JGB yields to some extent. However, it remains unclear whether this state of affairs will continue.
Restoring stability to Japan’s bond market may ultimately require a decline in crude oil prices. Apart from that, I think it is also important for the government to present a policy stance that takes the nation’s finances into account. The fact that US Treasury Secretary Scott Bessent, who visited Japan this week, apparently did not call on the Takaichi administration to pursue a more prudent fiscal policy in view of market concerns, as he had this January, may have been one contributor to the surge in long-term JGB yields on May 15.
Profile
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Takahide KiuchiPortraits of Takahide Kiuchi
Executive Economist
Takahide Kiuchi started his career as an economist in 1987, as he joined Nomura Research Institute. His first assignment was research and forecast of Japanese economy. In 1990, he joined Nomura Research Institute Deutschland as an economist of German and European economy. In 1996, he started covering US economy in New York Office. He transferred to Nomura Securities in 2004, and four years later, he was assigned to Head of Economic Research Department and Chief Economist in 2007. He was in charge of Japanese Economy in Global Research Team. In 2012, He was nominated by Cabinet and approved by Diet as Member of the Policy Board, the committee of the highest decision making in Bank of Japan. He implemented decisions on the Bank’s important policies and operations including monetary policy for five years.
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