Japanese bond sell-off intensifies: 10-year yield hits post-financial crisis high, 20-year auction demand weak.

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The sell-off in Japanese government bonds is intensifying.

On Wednesday, October 19, the benchmark yield on Japan’s 10-year government bond rose by 2 basis points to 1.765%, reaching its highest level since the global financial crisis in June 2008. The selling pressure quickly spread to longer-dated bonds, with the 40-year government bond yield hitting a record high of 3.695%.

Exacerbating market pessimism, Wednesday's 20-year government bond auction showed weak investor demand. Key indicators suggest market participants are cautious as the Japanese government is about to announce an economic stimulus package, adding further pressure on the yen and raising concerns about the sustainability of Japan’s debt.

At the heart of this market turmoil is the expectation that Japan’s new cabinet, led by Prime Minister Sanae Takaichi, is preparing to launch a supplementary budget far larger than anticipated. The market worries that this huge expenditure will have to be financed by a massive new issuance of government bonds, bringing additional supply pressure to the market.

Weak auction results highlight investor caution

Wednesday’s auction of 20-year Japanese government bonds directly reflected the market’s cautious sentiment. Data showed that the bid-to-cover ratio fell from 3.56 last month to 3.28, indicating waning investor interest.

A more crucial metric is the “tail,” the gap between the highest and average accepted yields, which widened significantly from 0.13 in October to 0.31. A widening tail is usually seen as a sign of weak demand. After the auction, the 20-year bond yield stood at 2.795%, close to its highest level since 1999.

Ryutaro Kimura, Senior Fixed Income Strategist at AXA Investment Managers, commented, “As many feared, the 20-year Japanese government bond auction fell short of expectations. Now that weak demand is a reality, bond investors should prepare for a further rise in yields ahead of next week’s 40-year bond auction.”

However, Keiko Onogi, Senior Government Bond Strategist at Daiwa Securities, said that the auction drew “tepid bids,” but it is unlikely to “trigger a further sell-off at the long end of the yield curve.”

Fiscal stimulus expectations stoke market concerns

The direct trigger behind the surge in Japanese government bond yields is the so-called “Takaichi trade” — investors betting on a massive fiscal spending plan by the new government. Initially, the market expected a supplementary budget of about 14 trillion yen, but officials later hinted it could be expanded to 17 trillion yen.

On Tuesday, a subcommittee of Japan’s ruling Liberal Democratic Party proposed expanding the budget to 25 trillion yen, which thoroughly shocked the market. Investors widely believe that such a huge spending plan would be funded by issuing more sovereign bonds.

Shoki Omori, Chief Strategist at Mizuho, pointed out: “The market is worried that the government’s stance is now quite dovish, and clearly believes the government will have to issue longer-term bonds to finance its spending plans.”

Goldman Sachs also stated that as investors grow wary of a stimulus plan exceeding expectations, Japan’s bond market will see a resurgence of “fiscal risk premium,” putting pressure on long-term sovereign debt and the yen.

Long-term yields soar, global spillover risks emerge

The sharp rise in Japanese government bond yields is not only a reflection of domestic fiscal pressures, but could also have repercussions for global markets. As Japan has long maintained ultra-loose monetary policy, its bond yields have been seen as a benchmark for the global debt market.

This surge in yields has been ongoing for some time. Since the beginning of this year, the 30-year bond yield has risen by 1 percentage point, while the U.S. 30-year yield has declined over the same period.

Mike Riddell, fund manager at Fidelity International, warned that risks at the long end of the Japanese government bond curve could quickly spill over into other markets, citing the global bond sell-off in May this year as related to volatility in Japanese bonds.

Meanwhile, the yen continues to weaken against the dollar. Traders say this reflects a “more chaotic” macroeconomic picture for Japan. Market participants are closely watching an extraordinary meeting soon to be held between the Bank of Japan, the Ministry of Finance, and the Minister for Economic Revitalization, which adds further uncertainty for investors’ decisions.

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