JGB Yield Volatility Expected as Investors Await Fed's Next Move

The 10-year Japanese government bond (JGB) yield is expected to remain volatile this week, potentially breaking above 3% and testing its upside. This development is tied to the Federal Reserve's next move after the release of the August Consumer Price Index (CPI) on September 11. Chair Kevin Warsh has outlined his reaction function, stating that with the labor market 'more or less at equilibrium', the Fed would consider tightening if underlying inflation rises and easing if it declines.

Warsh further clarified his threshold for action at the Jackson Hole symposium, saying that 'We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.' If core CPI inflation in August comes in higher than the consensus forecast of 2.4% YoY, a rate hike at the September 15-16 FOMC meeting would likely be seen as a near-certainty.

However, considerable uncertainty remains over whether Chair Warsh will actually raise rates. If the Fed decides to leave the policy rate on hold despite a stronger core CPI reading, concerns that it is falling behind the curve would put bear-steepening pressure on the US Treasury curve. Conversely, if core CPI growth is in line with or below the consensus forecast and the Fed keeps the policy rate on hold, US Treasuries would likely catch up.

The Bank of Japan (BoJ) is expected to raise its guidance target for the policy rate from 'around 1%' to 'around 1.25%' at its September 17-18 Monetary Policy Meeting. The market has priced in a greater than 90% probability of a rate hike, and any additional impact this week is likely to be modest.

The BoJ's Governor Kazuo Ueda will likely emphasize the importance of stabilizing underlying inflation at around 2% and reiterate the Bank's official stance that it will consider the timing and pace of rate hikes while assessing the likelihood that the baseline outlook for economic activity and prices will materialize, along with associated risks.