Japan’s 10-year government bond auction passed smoothly on Tuesday even though the benchmark yield was close to a three-decade high at 3% as markets are more optimistic that the Bank of Japan (BOJ) might raise interest rates in the near future.
The auction attracted reasonably firm demand, and markets were still waiting to know what the future of Japanese monetary policy, inflation and government borrowing is like. The result came at a critical point for Japan’s bond market, where yields have climbed sharply since the country’s long-standing ultra-loose monetary policy was abandoned.
10-year JGB yield is 3%
The yield on Japan’s 10-year government bond briefly reached 3% on Tuesday, a three-decade high. The move came just before the bond auction and just after the Bank of Japan’s September 18 monetary policy decision.
The increase in yields means that investors are looking for higher returns to hold longer-dated Japanese government debt as expectations for further monetary tightening increase.
Earlier this month, Tokyo's deputy governor Ryozo Himino left the door open to the possibility that a September rate increase is possible, which has led to speculation about the central bank's next move.
Market participants are now closely watching incoming economic data and comments from BOJ officials for clues about the timing and pace of future rate increases.
Auction Demand Remains Stable
The bid-to-cover ratio at Tuesday’s 10-year bond auction was 3.29, much higher than the previous auction, which was 2.56. It was also slightly above the 12-month average of 3.26.
The bid-to-cover ratio is the amount of demand received compared with the amount of bonds offered. In general, a higher ratio indicates better demand.
But market strategists suggested the auction was, in general, in line with market expectations but not so strong.
Miki Den, senior rates strategist at SMBC Nikko Securities, said that the result seemed to indicate that investors are looking for yields above 3% on 10-year Japanese government bonds.
That reflects the changing expectations around Japan’s interest-rate environment.
Japan’s Bond Market Undergoes Major Shift
Japan’s bond market has changed considerably since the BOJ ended the world’s last negative interest-rate policy in 2024.
For years, extremely low interest rates and aggressive central-bank bond purchases kept Japanese government bond yields extremely low. But the normalization of monetary policy has allowed yields to rise as investors reassess the value of Japanese debt.
Higher bond yields have many implications for the Japanese economy. They can increase borrowing costs for the government, businesses and households. At the same time, higher domestic yields can make Japanese bonds more attractive to local investors compared with overseas assets.
The shift will be especially important for global financial markets in that Japanese investors own much of the foreign bonds and other international assets.
Rate hike expectations are still high
Market expectations for a BOJ rate hike have strengthened in recent weeks. Overnight index swaps were around 90% likely to be raised in September, according to the information provided.
And what will come next is largely expected to be in September or October, but the exact timing will depend on the economic situation and inflation, growth and the central bank’s assessment.
The yen’s weakness is also something to watch. The Japanese currency is currently around 160 against the U.S. dollar, and so there is pressure on Japanese policymakers to tackle imported inflation and currency-related risks.
Japan has also spent a record $96.4 billion supporting the yen in the last month, illustrating the magnitude of the challenge policymakers have to tackle.
30-year Bond Auction in Focus
While Tuesday’s 10-year auction passed without major disruption, investors are looking forward to the 30-year Japanese government bond auction on Thursday.
The longer end of Japan’s yield curve has been under pressure more than ever because of concerns over fiscal policy and the vulnerability of the government to high levels of debt.
Due to the potential for super-long bonds, demand for super-long bonds will be closely watched. A weak auction could push long-term yields higher and potentially trigger a wider sell-off in the global bond markets.
The ultra-long end faces more uncertainty, especially because of concerns about fiscal expansion and further bond supply, Rinto Maruyama, senior rates and foreign-exchange strategist at SMBC Nikko Securities, said.
Global markets are also watching Japan
Developments in Japan’s bond market are increasingly important for investors worldwide. Japanese institutional investors are big players in the international bond markets, so a large increase in domestic yields could impact decisions about investing in US Treasuries and other overseas debt.
A sharp rise in Japanese long-term yields could potentially lead some Japanese investors to return to domestic assets if the risk-adjusted returns become more attractive.
That could have consequences for global borrowing costs and exchange rates.
And with the successful 10-year auction, demand has not collapsed even when the benchmark yield reaches 3%. But the new 30-year auction and the BOJ’s September policy meeting will give us important clues to where Japan’s bond market is heading.
With interest rates on the rise, a weaker yen and fiscal problems still affecting sentiment, Japan’s government bond market is going through a very critical time for that market and has implications well beyond the country’s borders.
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