Yield rise+slowdown in interest rate hikes. Japan's two-year government bond issuance sees strongest demand since 2024.

On Thursday, Japan's two-year government bond auction saw the strongest demand since August 2024, thanks to rising yields and market expectations that the Bank of Japan may not rush to raise interest rates further. The decline in the price of Japanese two-year government bonds narrowed, with the subscription ratio jumping from 3.54 in the previous auction to 5.24. Market concerns that the Bank of Japan may be behind the curve in combating inflation led to a 10 basis point increase in the yields of Japan's 20-year and 30-year government bonds. Reports suggest that U.S. President Trump is considering new military actions against Iran, causing oil prices to surge to wartime highs. This complicates the policy outlook for the Bank of Japan, as the surge in oil prices exacerbates inflation and casts a shadow over economic growth. This uncertainty is leading decision-makers to be more cautious, with Bank of Japan Governor Haruhiko Kuroda stating this week that more time is needed to assess the impact of the situation in the Middle East before deciding on further rate hikes. Ryutaro Kimura, Senior Fixed Income Strategist at BNP Paribas Asset Management in Paris, said, "Bond investors are shifting from long and ultra-long maturity bonds that are vulnerable to the risk of the Bank of Japan delaying rate hikes to shorter maturity bonds." The yield on Japanese two-year government bonds has slightly declined. The subscription ratio at Thursday's auction was significantly higher than the 12-month average of 3.6, indicating strong investor interest in two-year bonds. The tail (the difference between the average price and the lowest accepted price) narrowed to 0.005, compared to 0.012 last month. Kimura noted that the demand for short-term bonds is being driven by expectations of delayed rate hikes due to concerns about a potential escalation in tensions between the U.S. and Iran. However, short-term interest rates sensitive to policy decisions still face upward pressure. The Bank of Japan maintained its rates in April but raised inflation expectations, with three members voting against the decision highlighting concerns about rising prices. Meanwhile, the Federal Reserve also kept its policy unchanged, but with four members holding different views, it underscored the divergence in economic outlook and pushed up yields on U.S. two-year government bonds. In early April, the yield on two-year Japanese government bonds reached 1.4%, a three-decade high. Supported by demand related to Bank of Japan operations and liquidity management, this maturity bond typically attracts a wide range of investors, including banks and asset management companies.