FX Focus – MUFG Research

Looking at the performance of major government bond markets in Germany, Japan, the UK and the US since the end of June, several developments stand out. First, the hawkish repricing of central bank expectations has been a key driver of higher yields at both the short and long ends of the curve. Short-term yields have risen by more outside the US, reflecting expectations that the Fed will remain relatively cautious in tightening policy in response to higher energy prices.

Second, the Japanese yield curve has flattened significantly as the long end has been much better anchored. While the 30-year JGB yield is little changed, the 2-year JGB yield has risen by almost 50bps. Government bond curves in Germany and the UK have also flattened, although to a lesser extent than in Japan, providing some reassurance that long-term bonds are holding up relatively well. Even so, European bond markets have experienced the sharpest sell-off over the summer, underscoring their greater sensitivity to rising energy prices. Natural gas prices have surged to their highest levels since the US-Iran conflict began, intensifying inflation concerns.

Third, long-term market-based measures of inflation expectations, such as 10-year breakeven rates, have moved higher alongside rising energy prices, although there is little evidence that inflation expectations have become unanchored.

Finally, real yields across the major government bond markets have consolidated at higher levels after moving higher in Q2. The resilience of the global economy in the face of the energy price shock has helped to support higher real yields. The build-out of AI (click here) has been helping to support demand and boosted investor optimism over the global growth outlook.