Insufficient liquidity + Resurgence of interest rate hike expectations: Demand for Japan's 5-year government bond auction hits a five-year low

According to Zhitong Finance APP, due to insufficient market liquidity and the possibility of further tightening of monetary policy, the demand for Japan's 5-year government bond auction has reached its lowest level since 2020. This issuance led to a slight decline in bond prices across maturities from 2 years to 10 years, with the yield on 5-year bonds rising by 3 basis points to 1.07%.

The bid-to-cover ratio, a measure of demand, averaged 2.96, compared to 3.54 in the last auction, and the average over the past 12 months was 3.74.

Takuji Aida, chief economist at Crédit Agricole, stated, "The expectation that the Bank of Japan will raise interest rates this year has not disappeared."

According to the minutes of the Bank of Japan's meeting, one committee member indicated that the Bank of Japan might raise interest rates again before the end of the year, depending on the impact of U.S. tariffs. Overnight index swap trading currently shows a 57% probability of the Bank of Japan raising rates before the end of the year.

The yield on Japan's 5-year government bonds has risen again.

Mary Nicola, a macro strategist at Bloomberg, stated, "Japanese government bonds will face a new round of selling pressure. Inflation risks remain high, with the year-on-year increase in the producer price index in July slightly exceeding expectations. The GDP data to be released later this week may exacerbate stagflation concerns."

Another sign of weak demand is the tail gap (the difference between the average price and the minimum accepted price), which was 0.03, compared to 0.02 in last month's auction.

Concerns about poor liquidity and high volatility in the Japanese bond market have also intensified. Data from a brokerage firm showed that Japan's benchmark 10-year bonds saw no trading on Tuesday, marking the first time in over two years, with trading resuming only on Wednesday.

Globally, due to the overall mild inflation data in the U.S., expectations for a rate cut by the Federal Reserve next month have emerged, leading to a slight decline in U.S. short-term bond yields.

Aida from Crédit Agricole stated, "Another reason may be the boost in economic confidence brought about by rising stock prices. We believe that rising interest rates, including ultra-long-term rates, will help Japan completely break free from structural deflation and recession."

Following the blue-chip benchmark Nikkei index reaching a record high on Tuesday, the Japanese stock market rose for the sixth consecutive day on Wednesday. This increase was mainly driven by technology stocks, as the mild inflation data from the U.S. enhanced market expectations for a rate cut by the Federal Reserve, thereby boosting market sentiment