The Complex Relationship between JGB Yields, OIS Rates, and JPY Strength

In recent weeks, the 10-year JGB yield has shown an upward trend, reaching 1%, while the 3-month and 6-month overnight indexed swap (OIS) rates in Japan stand at 0.12% to 0.17%. Despite these bullish movements in JGB yields and OIS rates, the Japanese Yen (JPY) has failed to strengthen. The main drivers of short-term JPY weakness include broad-based US dollar strength and a deceleration in the lagging core-core Consumer Price Index (CPI) inflation trend.

The USD/JPY pair has managed to hold above its 20-day moving average, serving as a support level at 155.90. This is notable as both the 10-year and 30-year Japanese Government Bonds (JGB) yields have risen in recent weeks, reaching 1% and 2.17% respectively. The JGB yields and overnight index swap rates are indicating a possible Bank of Japan (BoJ) rate hike in July.

Inflation data plays a crucial role in guiding the BoJ’s path towards normalizing its ultra-accommodative monetary policy. BoJ Governor Ueda has hinted at an interest rate hike cycle in Japan contingent upon maintaining a sustained, stable achievement of the 2% inflation target along with strong wage growth. While Japan’s producer prices (PPI) have shown signs of improvement, the core-core CPI, excluding fresh food and energy, continues to exhibit a deceleration trend since August 2023.

The US dollar has shown strength against major currencies, driven by a recovery in US Treasury yields. The 10-year yield is inching closer to a key technical level of 4.50%. On a 5-day rolling performance basis, the JPY ranks as the third weakest major currency against the US dollar. A break below the key support level of 155.90 could invalidate the bullish bias for the USD/JPY pair, potentially leading to corrective slides towards 154.30 and 153.70.

The interplay between JGB yields, OIS rates, and USD strength has created a challenging environment for the JPY. While short-term weaknesses persist, the outlook for the Japanese economy remains subject to various external factors, including global economic conditions and monetary policy decisions. Investors and traders keen on the USD/JPY pair should closely monitor key levels and developments in both the US and Japanese markets to anticipate potential shifts in the currency pair’s direction.