High yields 'attract capital': Japan's 40-year government bond auction draws a bid-to-cover ratio of 3.1 times, the strongest demand since 2020.

Japan's 40-year government bond auction drew its strongest demand in six years, as elevated yields lured investors back to Japan's longest-dated debt and offered potential respite to fragile global markets. The auction attracted a bid-to-cover ratio of 3.1 times, the highest since 2020, up from 2.82 times at the previous sale and well above the 12-month average of 2.67 times. Demand was partly boosted by a reduction in the size of 40-year bond issuance in May, while expectations of more aggressive rate hikes by the Bank of Japan also helped ease inflation concerns. "The market expects the Fed and the BOJ to continue raising rates, which mainly puts upward pressure on short-end yields. At the same time, term premiums are narrowing as the market believes tighter monetary policy will eventually bring inflation under control," said Rinto Maruyama, senior rates and FX strategist at SMBC Nikko Securities. Speculation is growing that the BOJ could raise rates again as early as next month, after it already decided to lift its benchmark rate to a 31-year high of 1.25%. Kazuo Momma, former head of monetary policy at the BOJ, echoed that outlook in an interview. Meanwhile, Japanese and U.S. policymakers last week helped support market sentiment by using verbal intervention to curb the yen's decline. The strong auction could bring brief relief to global bond markets, which have recently been unsettled by rising AI spending, inflation triggered by the Middle East war and swelling government debt worldwide. The benchmark 30-year U.S. Treasury yield hit a 22-year high of 5.58% on Monday. Japan's 40-year bonds are traditionally favored by life insurers to match long-term liabilities, making the auction a key gauge of whether higher yields are drawing those buyers back. Masayuki Koguchi, chief fund manager at Mitsubishi UFJ Asset Management, said that despite the strong auction result, it still takes time to judge whether underlying demand is truly solid. Fiscal concerns continue to weigh on Japanese government bonds. It was previously reported that Japan is considering raising its medium-term defense spending target to 3.5% of GDP, aligning the country with NATO and other major U.S. allies. The potential increase has intensified scrutiny of Prime Minister Sanae Takaichi's broader fiscal agenda and how her government would finance additional spending. Meanwhile, shorter-dated bonds may remain under pressure amid expectations of faster BOJ rate hikes, said Maruyama of SMBC Nikko. Market focus has now shifted to Wednesday's two-year bond auction, with investors watching closely for signals on the BOJ's policy path. As one of the tenors most sensitive to rate expectations, the two-year yield is currently hovering near 2%, with traders pricing in the risk of faster monetary tightening.