A report from MUFG highlights rising risks in Japan’s financial markets caused by a sell-off in Japanese Government Bonds (JGBs). Concerns arise from the weak Yen and how it could affect market stability after the Bank of Japan’s recent rate increase. The JGB market’s 10-year yield hit 2.10%, the highest level since 1999, before dropping slightly. The recent 25 basis points rate hike by the Bank of Japan (BoJ) to 0.75% has raised worries about their cautious approach amid high inflation and upcoming fiscal stimulus aimed at boosting the economy early next year.

Potential Impact on the Takaichi Government

The biggest threat to the Takaichi government is financial instability, particularly ongoing Yen weakness, which could hurt government approval ratings. Observers are eager to see the government acknowledge these risks and adopt a cautious fiscal policy. Without clear signs of this caution, efforts to intervene in foreign exchange may not work. If Friday’s budget announcement does not address these concerns, selling of JGBs may continue along with further declines in the Yen. Japan’s financial markets are experiencing significant stress as we approach the final weeks of 2025. The sell-off in JGBs has pushed the 10-year yield to 2.10%, a level not reached since 1999. This situation is creating major challenges for the Yen, which is struggling close to 162.50 against the dollar.

Monetary Policy Concerns

Market anxiety comes from the Bank of Japan’s slow response to persistent inflation, which recent data shows remains stubbornly at 3.1%. The BoJ’s slight rate hike to 0.75% seems inadequate, especially with more government spending expected in the first half of next year. This mix of loose fiscal policies and hesitant monetary policies could weaken the currency further. For derivative traders, this environment signals high volatility, making options strategies especially relevant. The risk now is a sudden drop in the Yen, which could impact the government’s high approval ratings. In 2024, the Ministry of Finance intervened to support the Yen, but current instability in the bond market makes success uncertain. Everyone is watching the government’s budget announcement this Friday. If the government does not show commitment to fiscal discipline, we predict another wave of JGB selling and a sharp drop in the Yen. Implied volatility for USD/JPY options has already increased in expectation of this event. Traders expecting further Yen weakness might consider buying out-of-the-money USD/JPY call options, especially with strikes around the 165 level, to prepare for a potential breakout. On the other hand, if the budget shows unexpectedly strong commitment to fiscal discipline, it could lead to a rapid strengthening of the Yen. In that case, short-dated puts on USD/JPY could be a way to trade that quick reversal. Create your live VT Markets account and start trading now.

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