Japan's two-year government bond auction on Thursday attracted the strongest investor demand since August 2024, supported by higher yields and market expectations that the Bank of Japan may not rush into further interest rate hikes. The decline in the price of two-year Japanese government bonds narrowed after results showed the bid-to-cover ratio for the auction jumped to 5.24 from 3.54 in the previous session. Yields on Japan's 20-year and 30-year bonds rose by 10 basis points amid market concerns that the Bank of Japan may have fallen behind in curbing inflation. Reports that U.S. President Trump is considering new military action against Iran pushed oil prices to wartime highs. This has complicated the policy outlook for the Bank of Japan, as soaring oil prices fuel inflation while also casting a shadow over economic growth. Such uncertainty has made policymakers more cautious, with Bank of Japan Governor Kazuo Ueda stating this week that more time is needed to assess the impact of the Middle East situation before deciding on further rate hikes. Ryutaro Kimura, senior fixed-income strategist at BNP Paribas Asset Management, said, "Bond investors are shifting from long-term and ultra-long-term bonds, which are vulnerable to the risk of the Bank of Japan falling behind in raising rates, to shorter-term bonds." The yield on two-year Japanese government bonds has eased slightly. The bid-to-cover ratio for Thursday's auction was significantly higher than the 12-month average of 3.6, again indicating strong investor interest in two-year bonds. The tail, or the gap between the average price and the lowest accepted price, narrowed to 0.005, compared with 0.012 last month. Kimura noted that demand for short-term bonds is "driven by expectations of delayed rate hikes due to concerns about renewed escalation of tensions between the U.S. and Iran." Nevertheless, policy-sensitive short-term rates remain under upward pressure. The Bank of Japan kept interest rates unchanged at its April meeting but raised its inflation forecast, with three dissenting votes highlighting growing concerns about price rise risks. Meanwhile, the Federal Reserve also maintained its policy stance, although four members expressed differing views, underscoring divisions over the economic outlook and pushing up the yield on two-year U.S. Treasury notes. In early April, the yield on two-year Japanese government bonds briefly touched 1.4%, reaching a three-decade high. Bonds of this maturity typically attract a broad range of investors, including banks and asset management companies, supported by demand for collateral related to Bank of Japan operations and liquidity management needs.