Japanese bond auction: investor demand declines ahead of crucial elections

Against the backdrop of upcoming parliamentary elections, the Japanese government bond market is experiencing a period of heightened caution. Trading in long-term bonds shows clear signs of waning investor interest, indicating growing uncertainty among market participants ahead of political events.

Trading of 10-Year Government Bonds Reflects Increasing Market Caution

According to Jin10 data from February 3, participation in the 10-year Japanese government bond auction fell below the annual average. The bid-to-cover ratio was 3.02, down from the previous level of 3.30 and the 12-month average of 3.24. This decline in auction demand suggests that investors are adopting a wait-and-see stance until political prospects become clearer.

The tail spread settled at 0.05, remaining in line with the previous month’s auction. These metrics demonstrate a slowdown in demand precisely at a time when the market faces increased instability ahead of February’s elections.

Political Uncertainty: How Do Elections Affect Demand?

Market participants are preparing for significant volatility that may follow the House of Representatives election scheduled for February 8. Recent polls indicate a likely outcome: the ruling coalition will secure approximately 300 of the 465 seats, with the Liberal Democratic Party most likely to hold a majority on its own.

This political scenario would enable Prime Minister Sanae Takaiti to implement ambitious plans to increase government spending. In turn, this could lead to an expansion of public debt, which traditionally exerts pressure on long-term interest rates and influences government bond auction dynamics.

Yields at Historic Highs: What Is the Market Expecting?

In January, yields on Japanese government bonds reached multi-year highs, triggered by Prime Minister’s proposal to cut consumption tax. Although yields have since slightly retreated, the rate on 10-year bonds remains near 2.25% — the highest level since 1999.

This rise in yields adds further pressure on auction demand, as higher rates overvalue bonds for new investors, while simultaneously complicating government debt refinancing.

Market Expectations: When Will the Next Rate Hike Occur?

Derivatives based on daily swap rates indicate a 76 percent probability of the Bank of Japan raising interest rates by April. The market consensus fully prices in a 25 basis point increase by June of this year.

Such forecasts significantly influence government bond auctions, as expectations of rising rates prompt investors to reassess their portfolios and approach long-term bond participation more cautiously.

Outlook: Will Auction Demand Stabilize After the Elections?

As the political situation develops and the government’s fiscal policy direction becomes clearer, the market is likely to gain clarity on the scale of fiscal expansion. This should help investors better assess long-term prospects and return to government bond auctions with greater confidence.