Japan 2-year yields nearing 2% signal BOJ's yen battle isn't over
By Junko Fujita
TOKYO, Sept 29 (Reuters) - Japan's 2-year bond yield is edging toward a 2% threshold not crossed for three decades, in a sign markets think the economy is firmly on an inflationary path and that the central bank may even need to take interest rates into restrictive territory.
The pricing reflects a global sweep higher in yields as an energy shock and the AI buildout stoke inflation, but is running especially hard as investors wager that a cautious Bank of Japan is turning hawkish to shore up a wobbly yen.
As the tenor most sensitive to BOJ rate settings, the two-year yield has doubled in the past 12 months and is more than six times higher than it was this time in 2024.
The 2-year JGB yield reached as high as 1.975% on Monday, the highest since March 1995. The BOJ raised its key policy rate to a 31-year high of 1.25% earlier this month.
It is also in contrast with nearly a year ago when Prime Minister Sanae Takaichi came into office with markets expecting her to lean on the BOJ to keep rates low and hikes slow.
The resulting slide in the yen led, in July and August, to joint yen buying by Tokyo and Washington and more pressure from US Treasury Secretary Scott Bessent to get Japan's policy rates durably higher.
"Against this political and diplomatic backdrop, markets are becoming aware of the possibility that the Bank of Japan could proceed with consecutive rate hikes," Koichi Fujishiro, chief economist at Dai-ichi Life Research Institute, said in a note.
Compounding concerns about inflation from a weak yen are worsening fiscal strains in the world's most indebted major economy, where government debt exceeds twice the size of annual economic output and debt-servicing costs are already climbing.
Persistent pressure on the yen, even after this month's hike by the BOJ, a reported rate-check in the market and verbal warnings from Washington and Tokyo, shows the currency is getting policy attention that analysts expect to lead to higher rates.
"A weak yen and its impact on Japanese inflation is a big concern in the market," said Yuuki Fukumoto, senior researcher at NRI Research. "Previously, investors expected government interventions to stem the yen's weakness, but now they are increasingly seeing the BOJ's policy focus shift to the yen."
Japan's 5-year bond yield touched a record high of 2.43% on Monday and the one-month interest rate swap rate starting in two years , which market players see as the end point of the hiking cycle, rose to a record 2.5%.
Swap rates indicate a 36% chance of a rate hike to 1.5% in October, and traders have priced in a certainty for that move in December, according to money market broker Tokyo Tanshi. The timing may depend on the central bank's all-important Tankan report of sentiment among major manufacturers, due for release on Thursday.
"If capital investment is strong at the Tankan this week, the case for a rate hike in October may strengthen," said Takashi Fujiwara, chief fund manager at Resona Asset Management's fixed income division.