Japan’s two-year government bond auction Tuesday drew the strongest demand since October as investors were attracted to bond yields that have approached the highest since 2008.
Appetite for this maturity debt — which is sensitive to the outlook for monetary policy — has also been supported by continued demand for Bank of Japan-eligible collateral and surplus cash management.
The average bid-to-cover ratio was 4.47, compared with 3.90 in a sale last month and the 12-month average of 3.99. In another sign of firm demand, the tail, or gap between average and lowest-accepted prices, was 0.005, compared with 0.012 at the previous sale.
The sale’s impact rippled into the secondary market, with two-year bonds advancing, which nudged the yield down by two basis points to 0.82%. This slight drop in yields Tuesday contrasts with the broad trend in recent months, which has seen them moving higher on both short- and long-maturity debt.
The auction also comes ahead of a policy meeting Wednesday and Thursday by BOJ, which is expected to hold its benchmark interest rate steady at the gathering. Yet central bank officials see the possibility of another interest rate hike this year, according to people familiar with the matter.
“The two-year bond auction drew strong results, with yields rising to levels that reflect expectations of a BOJ rate hike,” said Takashi Fujiwara, chief fund manager at Resona Asset Management. “The yield level is good in terms of reflecting rate hike expectations, and holding the bond is unlikely to result in losses.”
Still, the signs of strong demand may not be enough to change the upward trajectory of yields.
What Bloomberg Strategists Say…
A risk-neutral yield, which signals a future path of short-term interest rates, has climbed to 0.7%, the highest in almost four months, according to estimates by Daiwa Securities. The move reflects renewed expectations that the Bank of Japan will raise its policy rate following the trade agreement with the US.
– Masaki Kondo, Rates/FX strategist
Traders of overnight index swaps are pricing in about a 75% chance the BOJ will hike rates by year-end, up from around 57% at start of the month. The benchmark interest rate is currently 0.5%.
Japan securing a trade deal with the US last week — which set tariffs at a lower-than-feared 15% — has reduced some uncertainty for the BOJ as it considers the need for higher interest rates to curb inflation.
One area of uncertainty that remains is politics, with a question mark hanging over Prime Minister Shigeru Ishiba’s future after the ruling Liberal Democratic Party-led coalition lost its majority in the upper house.
This has raised concerns that government spending may increase while taxes are reduced, which has fueled an advance in yields on longer-maturity Japanese government debt.
Ishiba’s leadership is seen as bond-friendly due to his strict stance on fiscal discipline.
