Still Favor Steepening Trades: Japan Rates Strategy | Japan

Research evidence excerpt

Still Favor Steepening Trades: Japan Rates Strategy | Japan

IdeaMRemaining available contingency reserves are estimated to only total around JPY1 trillion

(due to much of the JPY3 trillion added under the first FY2026 supplementary budget

having been earmarked for energy price relief after the Middle East situation turned

kinetic).

A previous Kumamoto earthquake in 2016 resulted in the government budgeting a total of

around JPY780 billion in additional funds for recovery and reconstruction. Contingency

reserves could end up being sufficient if the requisite expenditures are in the same

ballpark this time around. However, it will likely take time to assess the total toll of the

natural disaster and firm up the amount of spending that will be needed.

Such uncertainty is liable to result in a wider term premium being priced into the

super-long sector where overseas investors have now become such a major presence.

Rough estimation of the fiscal risk premium

As we discussed in "Fading Inflation Risk but Chasing Fiscal Risk", the 10y breakeven

inflation rate (BEI) moved in near lockstep with the term premia priced into the long-term

and super-long sectors throughout June, suggesting that the latter were being driven in

significant part by the impact of the Middle East situation on oil prices and FX (see Exhibit

1 ).

That relationship has, however, broken down since early July (see Exhibit 2 ), which we

attributed to a wider term premium being priced into the super-long sector in the wake of

the Takaichi administration’s growth strategy announcement amid expectations of a

significant increase in fiscal spending.

Exhibit 1: Cumulative change in 10y breakeven and Exhibit 2: Cumulative change in 10y breakeven and