Goldman Expect Continued Pressure On Swaps & Super-Long JGBs

Goldman Sachs suggest that if the BoJ wants to address broader dislocation in the JGB space “and further potential weakening of the Yen, it may ultimately have to revisit its YCC framework. We do not think intermediate steps, such as a modest widening of the tolerance band, is particularly useful, as markets are likely to converge to new levels in short order, potentially requiring the BoJ to continue relying on daily fixed rate operations to enforce the new level. That is because we believe the current environment is at the very least conducive to a convergence towards fair value, which our model suggests is closer to 60bp for 10s, and closer to where current 10-Year OIS rates are priced. If we are right in our fair value assessment, a complete abandonment of YCC might not be as disruptive as many fear, given that markets appear to be anticipating these levels to some extent (of course, yields could overshoot our fair value estimate on such an announcement). We would also note that our economists believe that significant changes to the BoJ’s policy stance are likely only after Governor Kuroda’s term ends (April 2023), with the caveat that “perceived inflation” bears watching. Overall, we suspect the market/BoJ stalemate will for now mean continued pressure on portions of the yield curve that are less directly affected by central bank intervention - either in swaps, or at maturities beyond the 10-Year point.”