So what was going on in the Japanese bond market because these developments could develop into a major risk to US treasuries and, by extension, global yields. In addition to the USD. At least, this was before the Japanese central bank basically signalled less long-end issuance, more issuance at the intermediate part of the curve. Nothing radical there but it highlights the risks associated with the long-end.
JGB yields surged two weeks ago as BOJ shifted policy gears, exposing cracks in market liquidity and testing investor confidence. With fiscal health intact but global carry trades at risk, Japan’s bond market looms as a potential disruptor in H2. Japan’s 30-year government bond yield surged to a record high of 3.18%. Since the pandemic, long-term JGB yields have been on an upward trend. With inflation and wage growth picking up, the Bank of Japan has been moving toward policy normalization. In recent years, the BOJ has ended yield curve control (YCC), started raising rates, and even begun quantitative tightening (QT)—all contributing to the steady rise in JGB yields.
Japan’s bond market is facing growing stress. The BOJ’s latest Bond Market Survey showed the JGB market functioning index fell sharply to -44 in Q2, the lowest since May 2023. Investor confidence took another hit after Japan’s 20-year government bond auction on May 20 showed weak demand. The bid-to-cover ratio dropped to 2.50, the lowest since 2012. The lowest accepted price was ¥98.15—far below the expected ¥99.80. The tail widened to ¥1.14, the largest since 1987, signaling poor liquidity and weak interest.
What is everyone so worried about? Japanese banks’ yen lending abroad—a proxy for medium-term carry trade magnitude—has surged to $1 trillion (145 trillion yen), often to asset managers, driven by rate differentials. Unlike futures traders, asset managers may unwind positions gradually, raising the medium-term risk of reversal. Rising JGB yields may prompt major Japanese life insurers to increase their JGB holdings. To fund this, they could sell US Treasuries. Since Japan is the largest foreign holder of U.S. debt, any shift in its holdings could have ripple effects across global markets.
Moving forward, there are several key dates ahead that could significantly impact the yen and Japan’s bond market:
- June: The Bank of Japan will announce its balance sheet reduction plan for next year. Markets currently expect a gradual pace—around a 6–7% reduction over two years. However, if the BOJ opts to speed up the process, it could put pressure on global markets.
- July: The 90-day tariff pause expires. If Trump resumes imposing high tariffs, it could trigger renewed global market volatility.
- Q3: If the U.S. Congress passes both the tax cut and debt ceiling bills, the Treasury is likely to increase long-duration bond issuance, pushing global yields higher.
- Q3–Q4: Markets expect the Fed to cut rates twice and the BOJ to hike once in the second half. If either central bank turns out to be more hawkish than expected, it could unsettle markets.
Bottom line: Japan’s financial markets will be a key area to watch in the second half of the year. With rising global uncertainty, market tolerance for surprises is falling. In this environment, close attention should be paid to the JGB market, alongside inflation trends and BOJ policy signals.
In relation to all the above, investors were on tenterhooks Wednesday Australia time for an auction of 40-year Japanese government bonds as volatility in the nation’s yields continues to rumble through global debt markets. The sale was seen as a key test for longer-maturity bonds amid concern from Tokyo to New York that rising government spending will take budget deficits into dangerous territory. The challenges in Japan’s bond market are amplified by the central bank rolling back its purchases and reluctance of institutional investors to fill the gap.
Super-long JGBs rallied Tuesday, sending yields on the 40-year maturity down 25 bps on signs that the finance ministry may be prepared to adjust debt issuance to ease the turmoil. The moves in Japan — which followed aggressive upward pressure on global borrowing costs last week — pulled yields lower on long-tenor debt from the US to Germany, and spilled over into currency trading.
The bad news? The auction was met the weakest demand since July, adding pressure on the government to reduce issuance. The average bid-to-cover ratio, a measure of demand, for Wednesday’s ¥500 billion ($3.5 billion) auction of March 2065 bonds was 2.21. That was lower than 2.92 at the last auction in March. The 40-year yield rose 5 bps following the sale, to 3.335%, while the 30-year rate jumped 7 bps.
The fact yesterday’s Japanese auction didn’t go very well supports the narrative that the government will adjust its issuance of super-long bonds, i.e. reduce supply and go shorter in the curve. The moves followed aggressive upward pressure on global borrowing costs last week that drove up yields on long-maturity debt from the US to Japan. In that context, Wednesday’s sale was a key test globally for longer tenors amid concern that rising government spending will take budget deficits into dangerous territory. In Japan it was also being viewed as an important gauge of appetite from large institutional investors, who have not filled the gap left by the central bank reducing its purchases.
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