Japan auctions off 40-year government bonds as a "reassurance pill", but fiscal concerns and uncertainties about the major election still loom large.

Prices of Japanese government bonds rose on Wednesday, with demand for the 40-year bonds auction reaching its strongest level since March, despite fiscal concerns heating up ahead of the election, temporarily easing market concerns about long-term debt. The yield on the 40-year bonds dropped by 2 basis points to 3.915%, further down from the historical high of 4.215% reached a week ago. The auction results showed an increase in key demand indicators, with the bid-to-cover ratio rising and yields on other tenor bonds falling in response. Shoki Omori, chief trading strategist at Nomura Securities, said, "The supply of 40-year bonds was absorbed smoothly, and strong buying interest after the auction helps stabilize sentiment in the ultra-long bond sector, alleviating short-term concerns about demand vacuum in the market." The auction provided some breathing space for the market. Earlier, Prime Minister Naoto Kan's proposal to exempt food sales tax for two years caused unprecedented market volatility. The Japanese Ministry of Finance will issue 10-year and 30-year bonds next week, which will further test if the strong demand for sovereign debt in the market can continue until the election on February 8. Differences in institutional views Meiji Yasuda Life Insurance Co. said in an interview that Japanese ultra-long bonds provide attractive investment opportunities and they are currently looking for the right buying opportunity. The Pacific Investment Management Company also remains positive on the 30-year bonds after the market turbulence. However, these comments were made before the auction. Strategist Mark Cranfield pointed out that today's auction of 40-year bonds passed the litmus test, with the bid-to-cover ratio slightly higher than the annual average and the winning yield slightly lower than expected. The bid-to-cover ratio for the Wednesday auction was 2.76 times, higher than the 2.585 times from the last auction in November and above the 12-month average of 2.53 times. But Omori cautioned, "This result should not be interpreted as a decisive shift in fundamental dynamics. Demand seems to be supported by higher yield levels and tactical buying rather than a general improvement in market confidence in ultra-long bonds." Political uncertainty clouds the market According to a Ministry of Finance official familiar with the situation, how to avoid market volatility during the election is a headache for the Naoto Kan government and the Bank of Japan. Recent polls show a slight drop in the prime minister's approval rating, highlighting the risks of her sudden announcement of the election. Ryutaro Kimura, senior fixed income strategist at Anshin Investment Management, said, "Naoto Kan strongly advocates reducing the consumption tax, which will dampen positive investment in ultra-long bonds. Therefore, market instability may persist until the political landscape is clear after the Japanese election." Japan's largest opposition party, the Democratic Party for the People, has promised a permanent reduction in the food tax, intensifying concerns in the market that fiscal discipline may be weakened regardless of the election outcome. The impact of a depreciating yen on price trends has also raised concerns among some Bank of Japan policy board members. Currency market linkage During the U.S. trading session on Tuesday, the yen against the dollar reached its strongest level since October. Comments from Japanese officials, including the finance minister, have fueled speculation that the government may intervene in the market to prevent the yen from weakening again. In addition, U.S. President Trump's hint of satisfaction with a weaker dollar has also helped push the yen higher. The finance minister's remarks came after Prime Minister Naoto Kan warned the government last Sunday to prepare to take action in response to a weaker yen and rising bond yields. However, she did not specify which market she was referring to. Miki Den, senior interest rate strategist at Sumitomo Mitsui Securities, said, "Volatility in the ultra-long bond sector may continue until after the election ends."