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JGB YIELD CURVE LIKELY TO FLATEEN

ADMIN || 21st October 2025

Traders are pricing for the Bank of Japan to eventually raise interest rates, along with bigger issuance of government debt targeted at the shorter end of the JGB curve.

The proposed coalition between LDP and Ishin will mark a turn toward a more growth-focused fiscal policy, replacing the broad cash support seen under the previous LDP–Komeito alliance.

Ishin’s participation could restrain fiscal largesse while keeping the door open for investment in strategic fields. Compared with the former LDP–Komeito coalition, this mix would be more favorable for fiscal balance.

Ishin favors a leaner, more efficient government. It calls for tax and social security burden cuts to support the working-age population, paired with proposals to curb spending and a target for primary balance surplus. Ishin supports monetary policy that balances price stability with economic growth.

Given that investors have limited appetite for the longest sector of the JGB curve and MOF is trimming issuance, that will mean more bonds in the 2-to-5-year sector.

The spread between five-year and 30-year JGBs currently stands around 190 basis points, after swelling to around 216 basis points last month, its widest in data going back two decades. Spreads are significantly higher than around 140 basis points seen in the run-up to the BOJ’s previous hike in January, leaving room to narrow ahead of the next tightening.

Markets are pricing in only a 25% chance of a hike in the 30th Oct meeting. This we believe is an opportunity to get paid in 2yr Japanese swaps. Hence our view for flattening on JGB yield curve is driven not only by the low pricing of a rate hike in Oct end meeting but also the fact that any increase in fiscal funding might have to be funded by increase in short end due to lack of demand on long end.

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