DM Rates: Breakevens have generally cooled but Japan stands out

Worries that inflation gets sticky from here.
Group Research, Eugene Leow05 Sep 2023
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    Aggressive rate hikes by developed market central banks in the cycle have generally cooled off breakevens. As headline CPI cools, 10Y breakevens across the DM have also fallen to much more manageable levels. 10Y US breakeven is now hovering around 2.26%, down from a peak of close to 3% in early 2022. However, even as this figure comes off, current levels are still clearly above the 10Y average of 1.98%. A similar picture can be traced when we average breakevens for the other DMs (Australia, Canada, Germany, Japan and the UK). We think the easy part of getting inflation down might be about to be over. Worries about sticky inflation are probably warranted as the global economy lurches into a period of heightened tensions and security worries. Accordingly, short of a major crisis, we think downside to breakevens might be limited from here on.

    Japan stands out from the DM crowd as 10Y breakevens are still very elevated. There are several reasons for this. First, Japan’s CPI has not been showing meaningful signs of downtrend (3.3% YoY in July) and this might be feeding into higher inflation expectations. Second, and arguably more importantly, the BOJ remains very slow in combating inflation. Japan’s 10Y implied real yield now stands at -0.48%. This is by far the lowest within the markets that we track. By keeping real yields low, there has been a concomitant bump up in breakevens as the yen weakens. Assuming that the BOJ continues to be dovish (relative to economic fundamentals), we would reasonably expect a grind higher in 10Y JGB yields towards the ceiling of 1%. Meanwhile, breakevens should be somewhat buoyant as low rates continue to stoke inflation worries.

    Eugene Leow

    Senior Rates Strategist - G3 & Asia


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