Japan's ultra-long-term government bond yields soar as the market braces for tariff deadlines and Senate elections

Japan is about to face two major risk events - the deadline for reciprocal tariffs on July 9 and the Senate elections on July 20.

According to the news from the Wind Trading Platform, Morgan Stanley released a latest research report indicating that in the short term, these two events are catalysts for fluctuations in the yen and Japanese government bond yields.

According to CCTV News, on the 6th local time, the Japanese Prime Minister stated that he would not easily compromise in the Japan-U.S. trade negotiations. Morgan Stanley pointed out that if the Japan-U.S. trade negotiations break down and reciprocal tariffs increase, it would heighten concerns about global economic growth, triggering a risk-averse mode, thereby pushing up the yen. Therefore, Morgan Stanley recommends maintaining a short position on USD/JPY, with a target price of 135 and a stop-loss at 151.

Subsequently, the market will focus on the Japanese Senate elections on July 20. If the ruling party loses, the market will anticipate more aggressive fiscal stimulus, which will push up the yields on Japan's ultra-long-term government bonds.

July 9 Approaches, Trade Negotiation Breakdown Will Push Up Yen

Morgan Stanley emphasizes that the short-term risk event is the final deadline for the "reciprocal tariffs" grace period on July 9.

Currently, negotiations between the U.S. and Japan are at an impasse, mainly stuck on the issue of automobile tariffs. According to CCTV News, Trump has threatened that if an agreement cannot be reached, Japan's total reciprocal tariff rate could rise from 24% to 30%-35%.

However, Morgan Stanley points out that many market participants hold a relatively optimistic view on the tariff issue, believing that the deadline on July 9 may be extended and that the final agreed tariff rate will not be higher than the current level.

For example, a mid-June QUICK foreign exchange monthly survey showed that nearly half of the respondents believe that a policy will be announced before July 9 to keep tariffs on automobiles, auto parts, steel, and aluminum at current levels or lower. Similarly, communication between Morgan Stanley and its clients shows that very few expect reciprocal tariffs to actually be implemented Morgan Stanley's baseline expectation is that existing tariffs on automobiles and other specific goods will remain unchanged, while overall reciprocal tariffs will ultimately be limited to a universal benchmark level of 10%.

Morgan Stanley stated that while a breakdown in negotiations is not the baseline forecast, the risk of a rupture cannot be completely ruled out. If negotiations do break down and reciprocal tariffs increase, it would exacerbate concerns about global economic growth, dampen global risk appetite, trigger a flight to safety, and subsequently push up the yen. Therefore, Morgan Stanley maintains a short position on USD/JPY.

Morgan Stanley also indicated that if negotiations break down, the market is expected to begin anticipating that the Federal Reserve's terminal rate will be lower, similar to the situation when tariffs were announced in April. The market price movements in April indicated that the market viewed the downside risks to economic growth as more severe than the upside risks to inflation, and subsequent data also proved that tariffs had little impact on prices, while economic activity and the job market began to unexpectedly weaken.

The Impact of the July 20 Senate Election on the Yen is Minimal, but Significant on Ultra-Long Bonds

After the tariff issue temporarily comes to a pause, the next major focus for forex market participants is Japan's Senate election on July 20.

The key focus of the July 20 Senate election in Japan is whether the ruling coalition (Liberal Democratic Party and Komeito) can maintain its majority by winning at least 50 of the 125 seats. The current campaign primarily revolves around economic stimulus plans, with the opposition advocating for a reduction in consumption tax, while the ruling party supports cash subsidies.

Morgan Stanley warns that if the ruling party loses, the market will anticipate more aggressive fiscal stimulus, which could push up Japan's long-term government bond yields.

In contrast to the UK, where last week saw a triple whammy in stocks, bonds, and currency due to market concerns that the UK government would loosen fiscal discipline again.

The UK faces a twin deficit (fiscal deficit + current account deficit) issue, making it heavily reliant on foreign investor funds to maintain fiscal operations. If overseas investors become concerned about its fiscal outlook, it would need to raise interest rates or allow its currency to depreciate to attract these investors to continue purchasing bonds.

However, Japan's situation is different, as Morgan Stanley points out. Japan has a large current account surplus and does not need to rely on foreign funds to fill its deficit, so the direct impact on the yen exchange rate will be relatively small. The concerns about Japan's fiscal situation are more reflected in steepening the yield curve of Japanese government bonds, as the proportion of foreign investors in the ultra-long bond market increases (due to insufficient local buyers), and they may demand a higher risk premium.