Japan looks like an outlier in tightening policy, with most other major central banks moving toward easing as economic growth slows. (UBS)

Japan’s central bank Governor Ueda said that capping bond yields would become “even more challenging from the year-end and heading into next year.” Meanwhile, Deputy Governor Himino said households could actually benefit from higher interest rates, while any harm to companies would likely be limited.


The remarks contributed to a roughly 12-basis-point rise in the yield on 10-year Japanese government bonds. Markets are now implying a roughly 35%chance that the central bank will end its negative interest rate policy at the next policy meeting on 19 December. The yield on the 10-year US Treasury initially rose around 7 basis points to 4.17%, interrupting a strong decline over recent weeks, though the yield later fell back to 4.14%. The rise was based on the assumption among many investors that Japan’s easy monetary policy exerts downward pressure on global yields.


But despite the signals from Japanese policymakers, we expect the global trend toward lower yields to continue, albeit with less momentum than recently:


Japan’s gradual move toward more normalized monetary policy has been flagged by the central bank for some time. As a result, we see the latest comments as consistent with our view that the BoJ would cease efforts to control the yield curve in the first quarter of 2024 and would end negative interest rates in the second quarter. We still expect the central bank to maintain a dovish tone, to avoid a sharp spike in bond yields. In addition, we don’t believe Japanese policy has been the anchor on global rates that some investors assume, and so we don’t expect a major spillover to global markets as Japan's rates rise.


US economic data continue to point to a cooling labor market and price pressures, supporting hopes for rate cuts from the Federal Reserve in 2024. Markets continue to imply a roughly 60% chance that the Fed starts to ease monetary policy as early as March, up from around a 20%probability just a month ago. This seems too optimistic in our view, and we expect cuts to begin only around the middle of 2024. However, data have continued to back the idea that easing is on the way. Data released earlier this week showed job openings falling to their lowest level in over two years in October, suggesting demand for workers is cooling.


This trend was supported by the ADP report for November, released on Wednesday, which indicated weaker-than-expected growth in private payrolls. That comes ahead of the release of government employment figures on Friday. Revised data also pointed to stronger productivity growth than previously estimated and a larger decline in unit labor costs—both of which readings support a more benign inflation outlook.


The downward momentum in Eurozone inflation will make it easier for the European Central Bank (ECB) to ease policy next year. Inflation pressures in the region are falling away quickly, slowing to 2.4% in November, the weakest pace since July 2021. This is partly because energy prices are now being compared to last year’s elevated levels following Russia’s invasion of Ukraine. However, inflation excluding food and energy has also been falling, as the region's consumers balk at higher prices. Core goods inflation has been running below zero and core services inflation is back to the central bank’s 2% target.


That has left the market pricing 100 basis points of easing from the ECB as soon as July, and 150 basis points by the end of the year. While we view this as excessive, we do expect around 75 basis points of easing for 2024, most probably starting around the middle of the year. We also expect the recent rally in the 10-year German Bund to be sustained, and go slightly further. Yields have declined about 75 basis points since mid-October to 2.17%, and we expect the yield to end next year around 2%.


So, Japan looks like an outlier in tightening policy, with most other major central banks moving toward easing as economic growth slows. This backdrop supports our preference for high-quality bonds, though we do expect the pace of the recent rally to moderate.


Main contributors - Solita Marcelli, Mark Haefele, Teck Leng Tan, Dean Turner, Christopher Swann, Vincent Heaney


Read the original report : Global yields on track to fall despite outlier Japan, 7 December 2023.