Japan’s Weak Two-Year Bond Sale Shows Growing Rate Hike Risk

Core Viewpoint - Japan's two-year government bond auction experienced weak demand, influenced by rising expectations of a near-term Bank of Japan rate hike due to sustained yen weakness [1][2][3] Group 1: Auction Performance - The bid-to-cover ratio for the auction was 3.53, lower than the previous sale's 4.35 and below the 12-month average of 3.66 [1] - The tail, or gap between average and lowest-accepted prices, increased to 0.012 from 0.002 last month, indicating weaker investor demand [1] - Bond futures maintained small losses following the auction results [1] Group 2: Market Expectations - Expectations for a Bank of Japan rate hike in December have risen, with overnight index swaps indicating a 57% chance of a move, up from 32% two weeks prior [2] - The two-year government bond yield reached 0.975%, the highest level since 2008, reflecting sensitivity to monetary policy expectations [2] Group 3: Investor Sentiment - Investors are cautious ahead of BOJ Governor Ueda's upcoming speech, which is anticipated to significantly influence interest rate decisions [3][6] - There is a noted reluctance among investors to purchase bonds due to potential increased issuance, as they await details on the Ministry of Finance's revised issuance plan [5] Group 4: Demand Dynamics - Despite the weak auction results, the two-year bond sector is considered relatively well-supported due to demand from overseas investors and its role as collateral in BOJ operations [6] - Tokyo's inflation remained steady in November, and industrial output unexpectedly rose, contributing to the likelihood of an imminent interest rate increase by the BOJ [7]