Global bond market sell-off intensifies investor wait-and-see sentiment, weak demand for Japan's five-year government bond auction.

Amid escalating concerns over high oil prices exacerbating inflation and triggering a global sell-off in the bond market, demand at Monday's Japan five-year government bond auction was weak. Data showed that the bid-to-cover ratio for this auction fell to 3.22, lower than the previous auction's 3.58 and below the 12-month average of 3.47. The tail (the difference between the average winning price and the lowest winning price) was 0.04, the same as the previous auction. As of writing, the yield on Japan's five-year government bonds was slightly below 2%, briefly surpassing this key level intraday; the yield on the ten-year government bonds rose by nearly 2 basis points to 2.736%; and the yield on the thirty-year government bonds rose by almost 3% to 4.109%, hitting the highest level since the issuance of these bonds in 1999. Mark Cranfield, strategist at Markets Live, commented, "Today's weak demand at the five-year Japanese government bond auction is below the average level of the past year, and the lowest winning price is below expectations before the auction. These indicate that even with yields reaching 2% for the first time this century, Japanese investors are not yet ready to significantly buy bonds." Wee Khoon Chong, senior market strategist for Asia Pacific at BNY Mellon Bank, stated that the weak demand "reflects the sudden surge in Japan's government bond yields, causing investors to adopt a wait-and-see approach for more attractive entry points and for the current global bond sell-off trend to stabilize." Fiscal concerns compounded by inflation pressures as Japanese bond yields rise Monday's Japan five-year government bond auction took place against the backdrop of a global sell-off in the bond market. The situation in the Middle East remains deadlocked, with significant differences between the U.S. and Iran on issues such as ending the war and reopening the Strait of Hormuz. This has kept international oil prices high, exacerbating concerns about inflation and pushing up borrowing costs for governments worldwide. Keisuke Tsuruta, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities, noted, "Global bond yields are rising sharply, and there are currently no factors that could alter the market sentiment that was sold off last week due to concerns about inflation and fiscal expansion." The rise in Japanese bond yields reflects two mutually reinforcing pressures. First is the global transmission of inflation - the rise in energy prices driven by the war is raising borrowing costs for governments across the world, and Japan is not immune. The second is domestic fiscal concerns - reports suggest that the Japanese government is considering compiling a supplementary budget, raising worries in the market about fiscal discipline. Although Japanese Finance Minister Satsuki Katayama reiterated last Friday that the government currently does not need to compile a supplementary budget and emphasized that the rise in Japanese bond yields is part of a global trend. It is worth noting that the high Japanese bond yields may attract more domestic investors back to the market, which could impact other sovereign debt markets. Kristina Hooper, Chief Market Strategist at Man Group, the world's largest listed hedge fund, said, "This will push up yields on other assets, especially U.S. government bonds." Bank of Japan paving the way for a rate hike in June In the context of escalating concerns about inflation due to the war in the Middle East, the Bank of Japan is expected to continue normalizing its monetary policy. In a survey conducted from May 7 to 14, 65% of the economists surveyed (40 out of 62) predicted that the Bank of Japan would hike rates by 25 basis points in June, raising the benchmark rate to 1%, in line with the results of the April survey. Of the 62 economists surveyed, all but one expected the Bank of Japan to hike rates by the end of September. At the same time, the survey showed that the Bank of Japan would raise the benchmark rate to 1.25% in the fourth quarter of this year and further increase it to 1.50% by the third quarter of next year, consistent with last month's survey results. Additionally, nearly three-quarters of the economists surveyed indicated that the continued threat of inflation in the next 12 months poses a greater risk to the Japanese economy than a slowdown in demand. A senior market economist at Mizuho Securities stated, "Considering that the economic, price, and wage conditions that support a hike currently exist, we believe that the June meeting, about six months after the December 2025 meeting, is the most likely timing for the next hike." The Bank of Japan last month kept rates unchanged at 0.75% to assess the impact of the war in the Middle East. However, three of the nine members of the Bank of Japan's Monetary Policy Committee voted against this decision and advocated for a rate hike to 1%, indicating policymakers' increasing vigilance against the inflation pressures caused by the energy shock from the war in the Middle East. One of the committee members who voted in favor of maintaining rates last month, Ekijo Hayashida, publicly turned hawkish and called for an early rate hike. Hayashida said last Thursday, "I judged that there was no need to rush the rate hike in April, but if there are no clear signals of economic downturn from the data, we should hike rates early." This statement suggests that he may join the hawkish camp next month and vote for a rate hike. The economists' expectations of a rate hike by the Bank of Japan in June also echo the minutes of the Bank of Japan's April meeting. The minutes revealed that several members of the Monetary Policy Committee advocated for an early rate hike at the meeting, with one member stating that a rate hike could be possible in June. The minutes quoted one member as saying, "Even if the situation in the Middle East remains uncertain, the Bank of Japan is highly likely to start hiking rates from the next meeting." Another member's opinion indicated, "Although there is no need for hasty action at present, as long as there are no clear signs of economic slowdown, the central bank should start hiking rates as soon as possible." There were also opinions suggesting that the current policy rate of the Bank of Japan is still far below the neutral rate level of the economy, and that the central bank should steadily raise rates every few months; if inflation risks increase further, they should accelerate the pace of rate hikes. The minutes also showed that many members expressed concerns that the conflict in the Middle East is intensifying inflationary pressures, increasing the risk of second-round effects, and accelerating the time for reaching the 2% core inflation target. One member was quoted in the minutes as saying, "With significant upwards adjustments in price expectations and high uncertainty about the situation in the Middle East, all scenarios show further risks of inflation." The member added, "Further, if supply-side constraints materialize, they will exert extremely strong upward pressure on prices." Data released last month showed that excluding fresh food prices, Japan's core inflation rate in March accelerated for the first time in five months due to concerns about rising energy prices caused by the war in the Middle East, reaching 1.8% year-on-year, up from 1.6% in February. The Bank of Japan also raised its forecast for the core inflation rate excluding fresh food for the 2026 fiscal year (April 2026 to March 2027) from the 1.9% predicted in January to 2.8%. However, the Bank of Japan's pace of normalizing its monetary policy may be constrained by the government. A government advisory group warned that given the deteriorating business financing environment and the uncertainty brought about by the situation in the Middle East, the Bank of Japan should proceed with caution in setting monetary policy. This statement was interpreted as a direct reminder to Bank of Japan Governor Haruhiko Kuroda, indicating that there may be stronger policy constraints on advancing rate hikes in the short term, especially at the upcoming monetary policy meeting next month. Shuichi Ohsaki, Senior Portfolio Manager at Meiji Yasuda Asset Management, commented, "In addition to growing concerns about the government compiling a supplementary budget, there is a strong belief that the Bank of Japan is unwilling to raise rates, exacerbating concerns that the Bank of Japan is falling behind the situation in combating inflation. The Japanese government must communicate clearly in fiscal and monetary policy to prevent the rise in interest rates."