Interest rate hike expectations and fiscal concerns push Japan's 10-year government bond yield to a 30-year high

According to Zhihui Finance APP, affected by fiscal concerns and rising market expectations for a future Bank of Japan rate hike, Japanese bond prices fell on Monday, with the 10-year Japanese government bond yield rising by 5.5 basis points to 2.93%, the highest level since 1996. Meanwhile, the 30-year bond yield also climbed to 4.06%, close to the record high reached in May.

According to informed sources last week, the government led by Japanese Prime Minister Sanae Takaichi supports a recent Bank of Japan rate hike, with the next possible hike coming in September or October. In addition, Japan's bonds are also under pressure due to fiscal concerns, as the Japanese government has not yet clarified how to fund a two-year food consumption tax reduction plan.

Ryotaro Kimura, Senior Bond Strategist at BNP Paribas Asset Management, said: “As investors return from holidays and market liquidity improves, the bond market has started to price in expectations for an accelerated Bank of Japan rate hike again. Unless the Takaichi administration abandons its expansionary fiscal policy, any decline in yields may be gradual, which means investors shouldn’t worry about missing buying opportunities.”

Japan's 10-year government bond yield rises to its highest level since 1996

The global market’s expectations for further monetary policy tightening are mounting, posing a threat to the bond market. Major central banks are facing multiple pressures, including higher oil prices stemming from the war in Iran, significant increases in government spending, and the artificial intelligence investment boom fueling economic growth.

Meanwhile, data released on Monday showed that Japan’s real gross domestic product (GDP) grew by 0.3% quarter-on-quarter in the second quarter, and by 1.1% on an annualized basis, both much lower than market expectations. This outcome may complicate the Bank of Japan's policy communications as it weighs the timing of its next hike.

Nonetheless, these data are unlikely to shift the Bank of Japan away from its rate-hiking trajectory. Overnight swap market pricing shows traders see as much as an 80% chance the Bank of Japan will raise rates at its next policy meeting on September 18.

After Japan’s GDP data was released, the yen strengthened slightly, rising from about 159.21 to the dollar before the release to 159.04 to the dollar. Since the US-Japan joint currency intervention at the end of July, the yen’s gains have narrowed and it remains well below its 10-year average exchange rate of 126.09.

Naoki Hattori, Chief Japan Economist at the Mizuho Research Institute, said: “Following the coordinated US-Japan intervention in July, I think external factors are also pressuring the Bank of Japan to hike rates. Considering all the factors, I believe a September rate hike remains the main scenario.”