Bank of Japan hints at "December rate hike"…yen strengthens, government bonds plunge

Japanese government bond yields rise to highest level in 17 years

BOJ Governor Kazuo Ueda: "We will weigh the pros and cons of a hike and make an appropriate judgment"

Probability of a December cut in the swap market jumps from 30% to 80%

Kazuo Ueda, governor of the Bank of Japan (BOJ), hinted at the possibility of a rate increase in December on the 1st (local time), and the Japanese yen strengthened. Japanese government bond yields rose to their highest levels in 17 years.

That day the yen rose 0.5% against the dollar in the Tokyo foreign exchange market, reaching 155.41 yen per dollar. The 2-year Japanese government bond yield, which is sensitive to monetary policy outlooks, rose 3bp (1bp=0.01%) to 1.02%, marking the highest level in 17 years. It is the first time since 2008 that the 2-year JGB yield has exceeded 1%. The benchmark 10-year government bond yield climbed 7bp to reach 1.87%. The 10-year yield is also at its highest level since 2008. Bond prices and yields move in opposite directions.

The Nikkei 225 index on the Tokyo Stock Exchange fell 1.89% from the previous trading day to 49,303.28.

Governor Kazuo Ueda said that the BOJ will review the "pros and cons" of a rate increase at the next policy meeting to be held in two weeks and will make an appropriate judgment on whether to raise rates. In the swap market, the possibility of a December rate cut had been assessed as low at around 30% or less. However, after Governor Ueda's remarks, the possibility of a rate cut this month became more certain, government bond prices fell, and the yen turned stronger.

The BOJ will hold its Monetary Policy Meeting to decide rates on November 18–19. If the policy rate is raised by 0.25 percentage points at that meeting, it would rise from the current 0.5% to 0.75%.

Hirofumi Suzuki, chief FX strategist at Sumitomo Mitsui Banking Corporation, said, "Governor Ueda's remarks appear slightly more hawkish than expected and could mark a turning point for the weak yen."

Chidu Narayanan, APAC chief strategist at Wells Fargo in Singapore, pointed out that Governor Ueda's remarks "differ markedly from his remarks after the last monetary policy meeting."

Currently, the swap market expects the BOJ to have an over 80% chance of raising rates at the December 19 meeting. A week ago it was only 23%. The probability of a rate hike at the BOJ's January meeting also surged to over 94%.

By contrast, in the United States, dovish remarks from Federal Reserve officials have led markets to assign a somewhat higher probability to a December rate cut. Federal Reserve Chair Jerome Powell is scheduled to speak late this evening Eastern Time.

The opposite moves by the BOJ and the Fed helped push the yen back into a stable range after hovering near its lowest levels in 10 months.

However, even after a rate increase in Japan, a large gap still remains between U.S. and Japanese interest rates.

The U.S. policy rate is currently 3.75%–4.00%, while even if Japan raises rates this month they would be around 0.75%. Therefore, it may take more time for the yen's weakness to fully end. Experts also expect it will take longer for any impact on carry trades using the yen, which some have expressed concern about, to materialize.

According to Reuters, the yield gap between U.S. and Japanese 10-year government bonds is currently 219bp, the narrowest since April 2022. However, U.S. Treasury yields remain considerably higher than Japanese government bond yields. In April 2022 the yen traded around 123 per dollar.

Guest reporter Jeong-a Kim kja@hankyung.com