Japanese two-year government bond auction falls flat, yields rise accordingly. Market bets on central bank increasing interest rates.

Demand for Japan's two-year government bond auction is weak, pushing up the yield of bonds with that maturity. The market speculates that the Bank of Japan may need to increase interest rates to curb inflation and boost the value of the yen. The bid-to-cover ratio for this two-year government bond auction was recorded at 3.26, lower than the previous auction of 3.53, and also below the 12-month average of 3.65. As a result, the yield on the two-year government bond increased by 1 basis point to 1.11%. In addition, futures for ten-year government bonds opened high but then fell. Less than a week before this auction, the Bank of Japan had just raised its policy rate to the highest level in thirty years. Governor Kikuo Iwkeda did not provide a clear guidance on future interest rate paths in his speech after the rate hike, which weakened the yen and led to a significant increase in bond yields. "There are still many doubts in the market about the policy direction of the Bank of Japan," said Katsutoshi Inadome, senior strategist at Sumitomo Mitsui Trust Asset Management. "This uncertainty may lead investors to avoid the two-year government bond, as this maturity is most directly impacted by policy changes." The yield on the two-year government bond, which is more sensitive to monetary policy expectations, had earlier this week climbed to its highest level since 1996. Meanwhile, the key indicator reflecting market expectations for future inflation - the ten-year breakeven inflation rate - also hit a record high since 2004 on Monday. However, Japanese Finance Minister Kaoru Yosano warned that for exchange rate fluctuations that do not align with economic fundamentals, the Japanese government has the "absolute freedom to take decisive measures". Following this statement, the depreciation of the yen and the rise in yields have eased since the beginning of this week. Investors are closely watching the government bond issuance plans related to the 2026 fiscal year budget, which is expected to be approved by the cabinet this Friday. A major trading house in Japan pointed out this month that it would make sense to increase the issuance of two-year, five-year, and ten-year government bonds for the new fiscal year starting on April 1, while also suggesting a reduction in the issuance volume of ultra-long-term government bonds. According to two unnamed government officials, Japan may reduce the issuance volume of ultra-long-term government bonds for the next fiscal year to around 17 trillion yen (equivalent to 109 billion US dollars), the lowest amount in seventeen years.