RPT - MNI POLICY: BOJ Vigilant Against JGB Steepening Risk

(Repeats story first published earlier on Sept 8, adding references to liquidity)

Bank of Japan officials are watching for signs that a stock market correction, combined with fiscal expansion concerns, could accelerate longer-term yield moves and steepen the JGB curve, potentially prompting the Ministry of Finance to cut issuance in Q4, which would mean the BOJ could scale back its own purchases in order to maintain liquidity, MNI understands.

Officials judge that the recent rise in JGB yields has mainly reflected economic fundamentals, including solid Q2 growth, persistent inflation, and some board members’ concerns over upside price risks, alongside moves in overseas markets. But they caution that foreign investors remain highly sensitive to Japan’s fiscal stance and are ready to push yields higher.

Political uncertainty also adds to the risk backdrop. Prime Minister Shigeru Ishiba revealed Sunday he would step down after the ruling coalition’s heavy defeat in the July 20 upper house election, only 11 months into his tenure. His successor, likely to lead a minority government, will need to work with opposition parties advocating fiscal expansion.

FRAGILE MARKETS

BOJ officials are also worried that declines in the Nikkei index could reduce demand for JGBs, especially at the longer end. Currently, gains in equities are allowing investors such as life insurers to buy longer-dated JGBs while selling low-coupon super-long bonds, but officials warn that a stock market correction – the Nikkei 225 has risen 11% year-to-date – would undermine this stabilising mechanism.

While 10-year JGBs remain supported by solid demand, following a 30-basis-point increase to1.590% this year, the super-long sector is seen as fragile. A sharp rise in longer-end yields could in turn push up the 10-year yield, which the BOJ is determined to keep from climbing too steeply. The Bank generally lets JGB yields move with the market but will step in to curb undesirable rises through bond purchases, while seeking to limit extra operations. (See MNI POLICY: BOJ Sees Bond Sell-Off As Reflecting Market)

U.S. Federal Reserve rate cuts may also help cap upward pressure on global rates, but officials fear concerns over the U.S. central bank’s independence and credibility could destabilise financial markets. They are also wary of renewed political calls for the BOJ to step up JGB purchases if yields surge due to fiscal expansion or overseas moves.

In response, the Ministry of Finance is reportedly considering a second cut this year to longer-end JGB issuance in Q4, while the BOJ may also scale back its own longer-end purchases during the same period, given its already high holdings in a relatively illiquid part of the curve. (See MNI POLICY: BOJ To Feel Way To Appropriate Balance Sheet Level)