"The 'bond market storm' is sweeping in, and global markets are watching today's Japanese bond auction."

The global bond market is experiencing a new round of intense turbulence, and Japan’s 20-year government bond auction scheduled for Wednesday (May 20) has become the most closely watched risk event in the market.

The auction comes less than 24 hours after the yield on Japan’s 20-year government bond hit its highest point since 1996. Meanwhile, according to a previous Wallstreetcn article, Japanese Prime Minister Sanae Takaichi is preparing to announce the drafting of an additional budget to cope with the impact of rising commodity prices caused by Middle East conflicts. Reuters, citing a government official, said the government may finance some of the added spending by issuing new bonds.

Analysts point out that this statement stands in stark contrast to Finance Minister Satsuki Katayama’s public position denying the necessity for an additional budget for weeks, further increasing market concerns about Japan’s fiscal sustainability.

These developments, combined with rising global inflationary pressures, are putting extra pressure on Japan’s super-long government bonds. The yields on 30-year and 40-year bonds have also both hit record highs this week. Investors will closely watch the bid-to-cover ratio at Wednesday’s auction, viewed as a key indicator of market sentiment.

Sensitive Timing, Highly Tense Market

The timing of this 20-year bond auction is particularly delicate. Just a year ago, an auction of the same maturity saw the weakest demand in over a decade, which the market remembers clearly.

Earlier this month, the 5-year, 10-year, and 30-year bond auctions were relatively stable, but after that, yields at the ultra-long end continued to climb, making the current market environment more challenging.

Yusuke Ikawa, a Japan strategist at BNP Paribas Securities, said:

"Super-long government bonds may continue to be sold off, and investors cannot afford to be complacent before the auction. As global yields rise, overseas investors are raising their investment thresholds and may need to re-evaluate the yield levels they require for Japanese government bonds."

Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities, pointed out:

"The rise in yields after the outbreak of Middle East conflict largely reflects the increased premium demanded by investors for compensation of inflation risk."

Sudden Shift in Fiscal Stance, Expectations of New Bond Issuance Rise

The sudden policy shift is one of the core triggers of this market turmoil. As recently as last Friday, Satsuki Katayama was still publicly reiterating that the government saw no need for an additional budget. Yet within just a few days, the situation has fundamentally changed.

According to a Wallstreetcn article, Bloomberg reported on May 18, citing insiders, that the supplemental budget is aimed at funding emergency relief measures rather than stimulating the economy. Last Friday, opposition party Democratic Party for the People took the lead in submitting an additional budget proposal amounting to 3 trillion yen (approximately $18.9 billion), offering a benchmark for government decision-making.

Japan usually finances additional spending by excess tax revenue, unused budget funds, or additional government bond issuance. However, since the current fiscal year has just started, the available size of excess tax or idle funds remains unclear, making further bond issuance much more likely—especially if the final budget exceeds the Democratic Party for the People’s proposal.

On the specific relief measures, the government is currently using reserve funds to subsidize gasoline prices, keeping the retail price cap at 170 yen per liter. Takahide Kiuchi, executive economist at Nomura Research Institute, stated in a report that if the subsidy strength of about 42.6 yen per liter is maintained, the relevant reserve funds will be depleted as soon as June 29.

According to Reuters, the government is also considering restarting gas and electricity subsidies during the July to September summer period, after these subsidies expired at the end of March. If these two measures proceed simultaneously, demand for a larger additional budget will further increase.

Multiple Pressures Overlap, Reinforcing Sell-Off Logic for Japanese Bonds

Beyond fiscal factors, the recent continued weakening of the yen is also increasing selling pressure on Japanese bonds.

Yen depreciation raises import costs, further strengthens inflation expectations, and increases pressure on the Bank of Japan to tighten monetary policy. According to swap market data, traders now price in a roughly 76% probability of a rate hike at the Bank of Japan’s June meeting.

The Bank of Japan is gradually exiting the bond market, making these pressures even more pronounced. Although the 5-year, 10-year, and 30-year bond auctions this month were relatively smooth, yields at the ultra-long end have continued to rise, showing the market’s clear limits in absorbing increased supply.

Barclays Securities strategists Ayao Ehara and Shinichiro Kadota stated in a research report: "Even yields at high levels may not be enough to support this auction." Sohei Takeuchi, senior fund manager at Sumitomo Mitsui DS Asset Management, noted:

"The 20-year government bond auction will be an important touchstone for assessing the market outlook."

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