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📝 Expect A JGB Market Driven Re-Test Of BoJ Policy: MUFG

The Fed is widely expected to raise rates by 75bp, while Japan’s central bank is seen leaving policy on hold. With the Japan-US interest rate differential widening further and the yen’s decline accelerating, we think the JGB market could resume trying to force the BoJ’s hand on policy revisions. The last time that happened was in June, when foreign speculators engaged in heavy selling of 10- year JGBs and succeeded in lifting the 10-year yield above the 0.25% top of the Bank’s target range, however briefly.

The spread between the 2-year government bond yields in Japan and the US jumped from 250bp to 320bp as a result. On the forex market, foreign speculators took this as a cue to begin aggressively selling the yen, and USD/JPY surged from 127 to 135. On the JGB market, foreign speculators stepped up their selling of long-term JGBs and JGB futures due to speculation the BoJ would eventually have to revise monetary policy to prevent further declines in the yen.

We think a return to the kind of market conditions seen in June would most likely be triggered by a further acceleration of the yen’s decline. As USD/JPY broke above the key psychological level of 140 in New York trading on Thursday, we cannot rule out a resumption of targeted selling of long-term JGBs and JGB futures by foreign speculators, based on the same rationale used in June. The correlation between USD/JPY and the 2-year US-Japan yield spread during 2022 (Graph 12) suggests USD/JPY would extend its rise above 140 if the yield differential widened to 370bp.

Amid these circumstances, there are probably already signs of a reemergence of a JGB market driven by selling to compel the BoJ to revise its monetary policy, similar to that seen in June. Indeed, this possibility is suggested by the relatively large rise for the yield on the cheapest-to-deliver issue with a remaining maturity of seven years. - MUFG Fixed Income



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