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Theme · past 4 weeksJapan

BoJ: a pause in October, December in play

The BoJ is pausing, not stopping: October is priced out, December is still in play, and the JGB curve has bull-flattened.

What it did to the curve

Front end

Yields lower

2-year

Long end

Yields lower

10–30-year

Curve

flatter

long minus short

A bull flattening: the 2-year eased from 1.975% on 28 Sep to about 1.91%, the 10-year from about 3.1% in early October to about 2.9–3.0%, and the 30-year from a record 4.235% on 5 Oct to about 4.00%. So 2s10s narrowed from about +112bp on 30 Sep to about +100–110bp, depending on the reading.

BoJ policy rate

1.25%

up+25bp on 18 Sep

Hiked on a 7–2 vote to the highest since 1995; the next decision and Outlook Report come on 30 Oct.

October hike odds

10% or less

downfrom about 36%

Swaps at the start of October against OIS and Bloomberg readings by 16 Oct; December is about 75–88%.

JGB 10-year

about 2.9–3.0%

downfrom about 3.1%

Mid-October against early October, when the 6 Oct auction averaged 3.101%: yields were at their highest since 1996.

JGB 2s10s

about +100–110bp

downfrom about +112bp

Derived, 30 Sep to mid-October (sources differ on the 10-year): the long end rallied while December pricing held up the 2-year.

What happened

The Bank of Japan hiked to 1.25% on 18 Sep (7–2), and for a moment markets wanted more. The 2-year, which tracks expectations for the policy rate, hit 1.975% on 28 Sep, its highest since March 1995. Swaps put about 36% on a back-to-back move in October. The on 1 Oct, with large manufacturers at +24, kept the debate open.

Then the Bank leaned against it. On 13 Oct, sources said officials were leaning against a back-to-back hike but kept December in view. By 16 Oct, October odds were 10% or less and December about 75–88%. Ueda’s message that day was still : underlying inflation is near 2%, cannot be allowed to accelerate further, and the Bank will basically keep raising rates.

The long end did the moving. The 10-year fell from about 3.1% in early October to about 2.9–3.0%. Its 6 Oct auction had averaged 3.101%. The 30-year fell from a record 4.235% on 5 Oct to about 4.00%.

Yields had dipped on 30 Sep on a report that PM Takaichi would vow a nimble response to markets, and the 8 Oct 30-year auction drew firmer demand than its 12-month average. With December pricing holding the 2-year near 1.91%, long yields fell further than short ones. 2s10s narrowed from about +112bp to about +100–110bp: a bull .

The yen is the swing factor. USD/JPY near 158 is close to 160, where Bloomberg flagged risk on 24 Sep, and a weaker yen raises import costs, and with them inflation. Ueda said timing depends on FX, AI-driven demand and the Middle East. The 30 Oct decision and Outlook Report are the next test.

Timeline

  1. · Japan

    Bloomberg flags yen-intervention risk as USD/JPY nears 160

  2. · Japan

    Ex-BoJ official Momma calls an October hike a real possibility, at about 20–30%

  3. · Japan

    JGB 2-year reaches 1.975%, the highest since March 1995

  4. · Japan

    JGB yields fall on a report that PM Takaichi will vow a nimble response to markets

  5. · Japan

    30-year JGB auction averages 4.109%, with firmer demand than the 12-month average

  6. · Japan

    Sources: BoJ leans against a back-to-back October hike but keeps December in view

  7. · Japan

    Ueda: underlying inflation near 2% must not accelerate; the Bank will keep raising rates

What could change it

Base case

The BoJ holds on 30 Oct, uses the Outlook Report to keep December alive, and hikes by December as pricing (about 75–88%) implies. The curve keeps its flatter shape.

Watch: BoJ, 29–30 Oct · FOMC, 27–28 Oct

Hawkish risk

October comes back. The IMF said on 17 Oct that the BoJ may need to tighten faster if inflation beats its forecast, and Tokyo’s September CPI excluding fresh food and energy ran at 3.0% against 2.5% expected. A slide in the yen towards 160 would add pressure.

Watch: BoJ, 29–30 Oct · FOMC, 27–28 Oct

Dovish risk

December slips. If the Outlook Report softens the inflation path or the yen steadies, the Bank can wait longer; the 2-year would then lead the rally and the curve could re-steepen.

Watch: BoJ, 29–30 Oct · FOMC, 9 Dec

How desks express it

BoJ Oct–Dec meeting-dated OIS spread

Spread

Receive Oct, pay Dec meeting-dated OIS (TONA)

The BoJ skips October but hikes by December: own the gap between the two meetings.

  1. 1

    Sources said on 13 Oct that the Bank leans against a back-to-back hike, and October odds fell from about 36% to 10% or less.

  2. 2

    Ueda said the Bank will basically keep raising rates, so December stays about 75–88% priced.

  3. 3

    Receiving October gains if the hold is confirmed on 30 Oct; paying December gains as the December hike firms up.

Wrong if: A surprise hike on 30 Oct, the risk Momma flagged, or a slide in the yen towards 160 hurts the receive leg. A soft Outlook Report on 30 Oct that pushes the next hike beyond December hurts the pay leg.

JGB 2s10s flattener

Curve

Pay 2y, receive 10y TONA swaps (DV01-neutral)

As hikes resume, the 2-year follows the policy rate up while a hawkish BoJ caps the inflation premium in the 10-year.

  1. 1

    The 2-year tracks the policy path, so a December hike to 1.5% would lift it from about 1.91%.

  2. 2

    Ueda’s line that inflation must not accelerate further supports the long end, where inflation risk is priced.

  3. 3

    2s10s already narrowed from about +112bp to about +100–110bp as the long end rallied; the flattener gains if hikes come and the gap keeps narrowing.

Wrong if: Fiscal fears return: the 30 Sep rally rested on a report of a nimble response from PM Takaichi, and the BoJ’s taper of JGB purchases (¥200bn a quarter) keeps adding long-end supply. A dovish 30 Oct meeting would also pull the 2-year down and steepen the curve.

Educational expressions of the theme — how a desk might position, not advice.

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The stories behind it

Sources