Japan's two-year government bond yield surged to its highest level since 2008, while the yen strengthened against the U.S. dollar, as mounting market signals point to an imminent Bank of Japan (BOJ) rate hike. Governor Kazuo Ueda delivered his clearest hint yet that the central bank could raise rates this month, stating it would "weigh the pros and cons of adjusting policy rates and make appropriate decisions based on domestic and global economic conditions, inflation trends, and financial market developments." He emphasized that any rate increase would merely fine-tune the degree of monetary easing.

The yield on interest rate-sensitive two-year Japanese government bonds (JGBs) rose 1 basis point to 1%, while five-year and benchmark 10-year yields climbed about 4 basis points to 1.35% and 1.845% respectively. The yen appreciated 0.4% to 155.49 per dollar at its peak.

During a closely watched speech in Nagoya on Monday, Ueda noted that the likelihood of achieving the BOJ's economic outlook is increasing, and conditions would remain accommodative even after a potential rate hike. Hirofumi Suzuki, chief FX strategist at Sumitomo Mitsui Banking Corporation, observed: "Growing expectations for a BOJ rate hike are driving yen appreciation and upward pressure on two-year JGB yields. Governor Ueda's remarks sounded slightly more hawkish than anticipated, potentially marking a turning point for the yen."

Market expectations for a December hike have surged dramatically. Swap markets now price in a 76% probability of a BOJ rate increase at its December 19 policy meeting, with the likelihood rising above 90% for January's meeting. This marks a sharp reversal from just two weeks ago, when markets assigned only a 30% chance to December action.

Strategist Mark Cranfield commented: "While Ueda left himself some wiggle room, his suggestion that conditions would stay loose even after hiking makes December action sound increasingly probable."

Meanwhile, Japan's Ministry of Finance plans to increase short-term debt issuance by ¥300 billion ($1.92 billion) each for two-year and five-year bonds, along with ¥6.3 trillion in treasury bills, to fund Prime Minister Sanae Takaichi's economic stimulus package. This is expected to pressure short-term bond markets.

Ryutaro Kimura, senior fixed income strategist at AXA Investment Managers, advised caution in bond markets, noting investors must consider "potential inflation reacceleration under Takaichi's fiscal expansion and deteriorating supply-demand dynamics from increased mid-term JGB issuance."

The yen has depreciated 5% against the dollar this quarter—the worst performance among G10 currencies—even as December rate hike speculation intensifies. With Japanese inflation consistently exceeding the BOJ's 2% target, critics argue the central bank has fallen behind the curve. Last week's weak two-year JGB auction demand reflected investor wariness amid rising rate hike risks.