Investors remain cautious amid the uncertain situation in the Middle East, with low demand for Japan's 30-year government bond auction.

Due to the uncertainty in the Middle East, investors remained cautious, resulting in subdued demand for Japan's 30-year government bond auction. On Tuesday, the bid-to-cover ratio for the auction was 3.12, lower than the previous auction of 3.66 and also below the 12-month average of 3.36, marking the lowest level since June last year. Following the auction, the Japanese government bond yields fell slightly as the market breathed a sigh of relief. Rinto Maruyama, a foreign exchange and interest rate strategist at Nomura Securities, stated that the auction was "slightly weak," but considering the high level of caution in the market before the auction, the results were still within a relatively acceptable range. He also mentioned, "Concerns about global inflationary pressures still exist due to the sustained high crude oil prices. In this environment, investors are finding it difficult to enter as buyers." Japan is one of the major economies most vulnerable to the impact of the Middle East situation, as more than 90% of its crude oil imports come from that region. Currently, the yield on Japan's 30-year government bond hovers around 3.76%, close to the historical high reached in January this year, highlighting concerns in the market about rising oil prices driving inflation higher. US President Trump continues to insist that freedom of navigation in the Strait of Hormuz must be part of any agreement and has threatened to destroy key Iranian infrastructure if his conditions are not met by the deadline set for Tuesday. Ataru Okumura, a senior interest rate strategist at Nomura Securities, mentioned that although the Japanese 30-year government bond auction was successfully completed, investors may not take on risks before the deadline set by the US regarding Iran, and therefore the market may continue to adopt a wait-and-see approach until then. Last week, Japan's 10-year government bond auction saw the weakest demand since May last year. In the US, upcoming auctions of 3-year, 10-year, and 30-year Treasury bonds, following recent poor auction performances, will pose a new test for investor demand. Some market participants suggest that Japanese government bond traders may not be satisfied with the widening tail and bid-to-cover ratio falling below the one-year average, although the figure remains above 3.0. The bond auction held before Trump's deadline regarding Iran was bound to face challenges. Relative value investors may wait for further developments in the Middle East situation and the results of the 30-year US Treasury bond auction on Thursday before making a decision to enter the market. The movement of Japanese bond yields is crucial for today's US and global financial markets. For years, Japan has struggled with deflation, and since 2016, the Bank of Japan has implemented a policy of controlling yields. Under this policy, the Bank of Japan has kept short-term borrowing rates negative and aimed to keep the yield on 10-year Japanese government bonds around zero. These low rates, along with significantly higher rates in other parts of the world, have led global investors to borrow in yen and invest in US dollars, euros, to invest in European and American stock and bond markets, emerging markets, and other areas. One of the challenges facing global financial markets is that the narrowing spread between Japanese and US bond yields may lead to the unwinding of yen-based arbitrage trades and prompt funds to flow back to Japan, causing pullbacks in other markets. For example, in August 2024, when the yield on Japanese government bonds surged, the large-scale unwinding of yen-based arbitrage trades caused turmoil in global markets. The US market is particularly vulnerable to such shocks, as Japan is the largest foreign holder of US Treasury bonds. If Japanese investors decide to withdraw funds back home due to rising domestic bond yields, the US Treasury market could lose a crucial buyer. Fluctuations in US Treasury yields will directly affect the valuation of US stocks.