High yields attract capital inflows as demand for Japan's 40-year government bond auction hits highest since March 2025

According to Zhihui Finance APP, Japanese 40-year government bond auctions saw the strongest demand since March 2025, as investors were attracted by higher yields.

The bid-to-cover ratio for Wednesday's auction was 2.82, compared to 2.702 at the previous auction and an average of 2.55 over the past 12 months. After the auction, Japanese bond prices remained largely unchanged.

Recently, Japanese government officials have emphasized the importance of the Government Pension Investment Fund increasing investment in domestic financial assets, which has supported Japanese government bond prices. After the 40-year government bond yield hit a record high of 4.355% in May, it is now hovering around 3.91%.

Japan's 40-year government bond yield hovers near historical highs

Japanese sovereign debt has shown some signs of strengthening, with last week's 20-year government bond auction bid-to-cover ratio approaching the seven-year high reached in April. Japanese Finance Minister Satsuki Katayama also suggested including government bonds in the tax-exempt Nippon Individual Savings Account (NISA) program.

“Following the strong performance of the Japanese 20-year government bond auction, the robust issuance of the 40-year bond indicates that even with medium to long-term yields continuing to rise, super-long-term bonds are still performing well,” said Miki Den, Senior Interest Rate Strategist at SMBC Nikko Securities. “Yields on super-long-term government bonds may remain near current levels.”

Last month, Japanese insurance companies purchased the largest amount of super-long-term government bonds in three years, further indicating that major buyer demand is stabilizing. Meiji Yasuda Life Insurance Company of Japan stated that it may increase its holdings of up to 1 trillion yen (about $6.1 billion) in Japanese super-long-term government bonds in fiscal year 2026.

Strategist Mark Cranfield said: “The 40-year Japanese bond auction held today attracted the strongest demand since March 2025. The highest yield was slightly below pre-auction poll data, but still not enough to ensure strong performance in the secondary market. Investors will soon be looking for yields above 4%, as the yen’s recent weakness shows no sign of reversing. This makes Japanese government bonds vulnerable to negative feedback loops caused by yen depreciation.”

Some investors remain focused on Prime Minister Sanae Takaichi’s expansionary fiscal policy, expectations for gradual Bank of Japan tightening, and the still significant interest rate spread.

The Takaichi administration approved an annual economic and fiscal policy plan on Tuesday, which emphasized the independence of the central bank, but the costly issue of sharply reducing the food consumption tax remains unresolved.

It is noteworthy that due to renewed escalation in US-Iran tensions driving up oil prices, the yen temporarily fell below the 163 level against the US dollar overnight, for the first time since 1986. The ongoing weakness of the yen is raising import costs and further amplifying domestic inflationary pressures in Japan.

Although the Bank of Japan raised its benchmark rate to the highest level since 1995 last month, investors remain concerned that its pace of rate hikes is insufficient to curb inflation. The Bank of Japan will hold a policy meeting next week, and markets broadly expect the policy rate to remain unchanged at 1.0%. The Bank of Japan continues to struggle with limited policy maneuverability as it tries to balance exchange rate stability, fiscal stability, and inflation control.