TOKYO: An auction of Japanese government bonds on Tuesday stands as a key test of investor appetite as yields climb to a three-decade high, putting scrutiny on the prime minister's record spending plans and the Bank of Japan's path toward higher interest rates.
The 10-year JGB yield is marching closer to the psychological threshold of 3%, and the auction's outcome could affect Japan's funding costs and global bond markets as investors gauge whether yields have further room to rise.
Budget requests from ministries and agencies for fiscal 2027 are expected to reach 140 trillion yen ($876.2 billion), far beyond last year's all-time high of 122.3 trillion yen.
Japan's surge in borrowing costs is increasingly being viewed as a cautionary example for other heavily indebted nations. Yields in the U.S. and Europe have also recently touched multi-year highs on similar concerns over higher central bank rates, inflation, growing deficits and debt loads.
While fiscal concerns are driving up longer-term yields, Japan's shorter-term rates are at historic highs on bets the BOJ will accelerate rate hikes, with U.S. Treasury Secretary Scott Bessent saying on Sunday he expects central bank Governor Kazuo Ueda to "do the right thing" on monetary policy.
"With various cues putting upward pressure on JGB yields, it would be hard to actively bet on the 10-year bonds," said Yusuke Matsuo, senior market economist at Mizuho Securities. "Not only in domestic markets, JGBs are under pressure from outside Japan, such as from the overnight remarks from Bessent."
The 10-year JGB yield reached 2.95% on Monday, a level not seen since September 1996, while the 2-year yield reached a 31-year high of 1.75% and the 5-year set a fresh record of 2.21%.
Japanese Prime Minister Sanae Takaichi told the Yomiuri newspaper on Sunday she aimed to cap bond issuance to around 40 trillion yen for the fiscal 2027 budget, seeking to reassure investors about a fourth consecutive year of record spending and a tax cut on food purchases.
The finance ministry expects debt-servicing costs to rise 17% to a record 36.64 trillion yen ($230 billion) in the next fiscal year, Kyodo News reported last week, citing sources close to the matter, reflecting an increase in the assumed interest rate to a 29-year high of 3.8%.
The rise in yields may act as enticement when the Ministry of Finance sells about 2.6 trillion yen in 10-year bonds on Tuesday. But with prevailing market views that yields will continue to grind higher, demand has been weak in the past two auctions.
Concerns about increased debt issuance along with recalibration of the BOJ's rate hike path remain as headwinds for JGBs, said Norihiro Yamaguchi, lead Japan economist at Oxford Economics.
"While the current yield level is certainly attractive, expectations of further increases in yields remain strong," Yamaguchi said.
Tuesday's bond sale will be followed on Thursday by an auction of 30-year debt.
Along with considerations about Japan's budget and bond issuance, investors must contend with shifting expectations for the Federal Reserve, the BOJ, and what may emerge from a two-day meeting of Group of 20 finance leaders.
"The auction takes place at a delicate time ahead of various market-moving cues both inside and outside Japan," said Masahito Sugawara, senior strategist at Daiwa Securities. ($1 = 159.7900 yen) - Reuters
