Japan's Two-Year Bond Auction Demand Hits 16-Year Low Amid Rising Rate Hike Speculation from BOJ

TradingKey - Demand for Japan's two-year government bonds hit the lowest level in 16 years this Thursday, as market speculation intensified that the Bank of Japan (BOJ) will raise interest rates later this year, coupled with expectations of increased short-term debt issuance. This development indicates that the pressure on long-term bond yields is beginning to spill over into the short-term spectrum.

The auction's average bid-to-cover ratio was 2.84, significantly down from the previous 4.47 and below the 12-month average of 4.01, marking the lowest level since 2009. Another metric, the tail, which measures the gap between the auction's average and the lowest accepted price, widened to 0.022 yen from 0.005 yen previously, signaling reduced investor appetite.

Following the auction results, yields on the two-year Japanese government bonds, which are sensitive to monetary policy changes, briefly rose to 0.874% on Thursday, just a few basis points shy of the highest level since 2008. This suggests that the market is betting on a possible BOJ rate hike soon, given the strong economic growth and persistently high inflation.

Data released last Friday showed that Japan's core CPI rose 3.1% year-on-year in July, surpassing the market expectation of 3% and significantly exceeding the BOJ's 2% target, indicating persistent inflationary pressures.

Omar Slim, Co-Head of Asia Fixed Income at PineBridge Investments, noted that with increasing evidence of domestic inflation in Japan, a 25 basis points rate hike by the BOJ could be expected by year-end.

Moreover, BOJ Governor Kazuo Ueda had earlier stated that ongoing wage increases amid a tight labor market would further fuel expectations of a rate hike, possibly as early as October.

On Thursday, BOJ official Junko Nakagawa also hinted at a rate increase, stating that Japan's current economic environment is more conducive to a rate hike compared to April, and reiterated that the central bank would raise the benchmark rate if conditions permit.

This Friday, Japan's Tokyo core CPI data will be released, which is expected to show strong readings, further bolstering the BOJ's confidence in raising interest rates. Additionally, the weak outcome of the recent auction has made the market wary of next week's auctions for 10-year and 30-year Japanese government bonds.