Demand Is Weak in First of Two Key Auctions of Japanese Bonds

The Japanese government’s auction of 10-year bonds met weak demand on Tuesday, adding to the challenges of policymakers after investors baulked at the yields on offer in sales last month.

(Bloomberg) — The Japanese government’s auction of 10-year bonds met weak demand on Tuesday, adding to the challenges of policymakers after investors baulked at the yields on offer in sales last month.

The Ministry of Finance sold 10-year notes on Tuesday with a lower-than-expected cut-off price, indicating limited appetite from investors. That resulted in an average yield of 0.657%, the highest in more than nine years. 

The next test comes with the sale of 30-year securities on Thursday in a market that’s still trying to gauge how far and fast yields will rise after the Bank of Japan adjusted its yield-curve control program in July. 

“The auction confirms sluggish demand near 0.65% in yields,” said Ataru Okumura, senior Japan rates strategist at SMBC Nikko Securities Inc. “Yields are likely to rise in the medium term amid speculation of BOJ policy adjustments, keeping investors’ cautious stance.”

A dropoff in demand for Japanese government bonds also underscores the challenges the BOJ will face in trying to unwind a super-easy policy that’s been in place for a decade. Rising interest rates will make it pricier to borrow money and if they trigger a strengthening in the yen, that may weigh on Japan’s exporter-heavy share market. Higher yields will also mean that the government’s debt-servicing costs will climb next year.

The costs will increase 11.5% from the previous year to ¥28.1 trillion next year at the budget request stage, according to a document seen by Bloomberg. 

A worsening in Japan’s finances is should drag on investor confidence toward longer bonds, but the way the system is structured means that Japan’s auctions won’t fail. The finance ministry requires 20 primary dealers — Japanese banks and brokerages and their foreign peers — to each bid for at least 5% of the planned issuance if needed, meaning the government will never fall short of demand when offering JGBs.   

Bond auctions in Japan last month underscored the weakness of demand for debt as investors waited for higher yields. 

At a 20-year note auction last month, the so-called tail, or the difference between average and cut-off prices, was the widest since 1987, a sign of reduced investor appetite for the bonds. That sent 20-year yields higher in the following days, reaching a seven-month high of 1.42% on Aug. 23. A two-year debt sale last week, meanwhile, drew the lowest bid-to-cover ratio since 2010, in another indication of sluggish demand. 

“Investors are probably seeking higher yields as US long-term rates have increased,” said Ayako Sera, market strategist at Sumitomo Mitsui Trust Bank Ltd. “Although super-long JGB yields have risen somewhat, their levels are not high enough to encourage life insurers and pension funds to buy aggressively,” she said. 

Next Test

Sera added that traders are more concerned about the outcome of Japan’s 30-year bond auction this week than the 10-year sale. 

Traders are also trying to judge the level of yields needed for Japanese buyers to load up at home and offload foreign holdings like Treasuries, European and Australian bonds. That potential repatriation risks exacerbating this year’s global bond selloff, with the European Central Bank saying in May a shift away from low interest rates in Japan could test the resilience of worldwide debt markets.

Japan’s 10-year yield traded at 0.655% on Tuesday after reaching a nine-year high of 0.675% on Aug. 23. Traders have been testing the BOJ’s resolve to prevent a too-rapid rise in yields after it tweaked YCC to effectively allow it to climb as high as to 1%. But the central bank has been stepping into the market to support bonds when yield increases were rapid.

The yield on the 30-year debt climbed to a more than seven-month high of 1.69% on Aug. 23 before stabilizing at 1.665% on Tuesday. 

As long as 10-year yields remain around current levels, “it is likely that markets will only see short-covering demand,” said Shoki Omori, chief desk strategist at Mizuho Securities Co. “There is growing vigilance ahead of auctions and that’s likely to continue until market participants see auction results for September.”

–With assistance from Masahiro Hidaka.

(Adds details of auction results.)

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