The bond market gets a temporary respite! Japan's 30-year government bond auction ends smoothly, with yields exceeding 4% attracting buyers

According to Golden Ten Data APP, the highly anticipated Japanese 30-year government bond auction was smoothly completed on Thursday, with the winning yield exceeding 4%, providing a temporary respite for the recently sold-off global long-term bond markets. The bid-to-cover ratio for this auction was 3.79, compared to 3.86 in the previous auction and a 12-month average of 3.52. After the auction results were announced, Japanese government bond futures maintained their upward trend.

Before the auction, Japanese government bond yields fell sharply, with the 30-year yield dropping by 10 basis points to 4.065%, mainly due to the retreat in international oil prices boosting sentiment in global bond markets. Nevertheless, investors remain cautious. With global inflation concerns unresolved and major central banks continuing to send hawkish signals, long-term yields in major economies are still hovering at their highest levels in decades.

Before the auction, Japanese 30-year government bond yields fell

Ryotaro Kimura, Senior Bond Strategist at BNP Paribas Asset Management, stated that although the sharp decline in yields ahead of the auction was partly due to short covering, the relatively high bid-to-cover ratio indicates that "it is too early to conclude the results were poor." He added, "If market concerns about rising interest rates ease, Japanese life insurance companies may be more proactive in purchasing 30-year Japanese government bonds at a 4% yield."

Rising Rate Expectations & Unresolved Fiscal Worries Make the Long Bond Outlook Uncertain

This auction comes at a time when market expectations for the Bank of Japan possibly accelerating monetary tightening are rising. Overnight index swaps show the market has fully priced in a rate hike by the Bank of Japan at the meeting on September 18. Previously, Bank of Japan Governor Kazuo Ueda hinted the upcoming policy meeting may see a rate hike, stating decisions will be based on an assessment of upside risks to prices. US Treasury Secretary Wally Adeyemo emphasized the need for action by the Bank of Japan, further strengthening the rate hike expectations in the market.

It is also worth noting that Takata Hajime, one of the most hawkish members of the Bank of Japan, said that a substantial rate hike and consecutive hikes cannot be ruled out.

However, the auction details hide signals of caution. The tail (the price difference between the average winning price and the lowest winning price) widened from 0.21 last month to 0.28 this time, indicating some participants are becoming more conservative in pricing.

Takahiro Otsuka, Senior Fixed Income Strategist at Mitsubishi UFJ Morgan Stanley Securities Company, commented: "The overall results are somewhat weak. Amid expectations for a Bank of Japan rate hike and fiscal uncertainty, Japanese 30-year government bond yields may still have room to rise further."

Strategist Mark Cranfield believes: "Today's 30-year government bond auction demand was solid, with yields above 4%, offering temporary support to long-term bonds. However, the minimum winning price was below market expectations before the auction, and the tail spread widened compared to the previous auction, which deserves attention. Judging from the buyer structure, major fixed income institutions participated broadly, and the absorbing capacity is decent. US Treasury traders will be relieved, as this trend has a slightly positive impact on the US yield curve."

Nevertheless, fiscal worries remain unresolved. Record-breaking spending requests submitted by various Japanese departments have brought Prime Minister Sanae Takaichi’s fiscal expansion plans into focus, with rising market concerns about how the extra spending will be financed and how many new government bonds the government will need to issue. These worries coincide with the benchmark Japanese 10-year government bond yield touching the 3% level for the first time in thirty years. Currently, global bond sell-offs have pushed long-term government bond yields to their highest levels in nearly twenty years.

Later this month, the Japanese Ministry of Finance will hold a meeting with primary dealers, at which the supply and demand landscape of the bond market will likely be a key topic of discussion.