- The yield on Japan's 10-year government bonds rose by 3 basis points to 2.675% on Monday, marking the third consecutive day of increases, as concerns over inflation rebound and fiscal deterioration due to potential fiscal expansion continue to escalate.
- Media reports revealed that Prime Minister Sanae Takaichi plans to implement a new growth strategy, aiming to guide public and private investments totaling approximately $2.3 trillion in 17 strategic areas by 2040, sparking expectations of increased Japanese bond supply and policy reassessment.
- Although Japan's core inflation rate in May was below the Bank of Japan's (BoJ) 2% target for the fourth consecutive month, the market remains highly attentive to the possibility of the central bank continuing to raise rates after increasing them to 1%, influenced by high energy costs and pressure on the yen's exchange rate.
Fiscal Expansion Expectations Trigger Bond Market Pressure
The Japanese government bond market continued its downward trend today, with yields rising across all maturities. The sell-off was primarily driven by the Japanese government's latest long-term investment plan. According to a draft disclosed by the media, the government plans to mobilize up to $2.3 trillion in public and private funds over the next decade. This massive investment total has heightened fixed-income investors' concerns about future increases in government bond issuance, putting pressure on long-term yields.
Long End of the Yield Curve Faces Supply Pricing
Regarding this enormous investment plan, SMBC Nikko Securities' senior rate strategist Ataru Okumura pointed out that fiscal expansion could further elevate domestic inflation levels, leading to rising interest rates and increasing concerns about the sustainability of public finances. Analysts believe that if the plan is officially implemented, the marginal changes in Japan's fiscal and monetary policies could resonate, causing the bond market to fall into a cycle of rising yields and expanding fiscal deficits.
Cooling Inflation Data Does Not Halt Rate Hike Expectations
On the monetary policy front, although macroeconomic data released on Friday showed that Japan's core inflation rate in May remained below the central bank's 2% target and slowed for the fourth consecutive month, it did not significantly alter the bond market's hawkish pricing. Policymakers are currently focused on the risks of imported inflation driven by rising energy costs and yen depreciation. Bond market traders generally expect that even if short-term inflation data declines, the Bank of Japan is likely to maintain a gradual tightening of monetary policy after raising the policy rate to 1%.
Institutional Views and Interest Rate Risk Premium
Skye Masters, Head of Market Research at National Australia Bank (NAB), stated that the latest inflation data is unlikely to change the Bank of Japan's current inclination towards gradual policy tightening. As the macroeconomic environment evolves, the risk premium in the fixed-income market is being reassessed. If core inflation rebounds again due to fiscal policy stimulus, the market's pricing of the terminal rate for rate hikes may face further upward revisions, thereby keeping the government bond yield curve under upward pressure.
