Japanese Government Bonds (JGBs) have recorded gains for a consecutive week, extending their upward trend. This positive sentiment was supported by a smooth five-year bond auction, which helped ease concerns regarding interest rate hikes, fiscal risks, and inflation. Super-long-term bonds led the advance, driving yields on 20 to 40-year bonds down by at least 10 basis points, while yields on shorter-dated bonds also declined.

The bid-to-cover ratio for the five-year bond auction increased to 3.10 from 3.08 in the previous auction, marking the first rise in demand since last September. As the U.S. Treasury market reopened following a holiday, last week's rally in U.S. Treasuries continued into Tuesday, with interest rates in Australia and New Zealand also edging lower. In contrast, equities traded in Tokyo and U.S. stock index futures saw declines.

Ryutaro Kimura, Senior Fixed Income Strategist at AXA Investment Managers, commented, "The favorable outcome of today's five-year bond auction appears to have encouraged investors to take long positions in JGBs. Observing the yen's appreciation during Tokyo hours and the drop in U.S. stock index futures, I believe the decline in rates today is driven by safe-haven demand, fueled by weakening global inflationary pressures and growing economic concerns."

Amid the shift in market sentiment, Japanese long-term bonds have staged a strong rebound. This auction was the first regular bond sale since Prime Minister Sanae Takaichi's historic election victory earlier this month. Although yields had surged to multi-year highs in January due to fiscal worries, they retreated following the vote as investors bet that Takaichi's solid majority would bring clearer policy direction and reduce extreme fiscal risks.

Investors are also assessing whether a politically strengthened Takaichi will seek to slow the Bank of Japan's rate-hike trajectory to protect economic growth or encourage central bank action to support the yen. BOJ Governor Kazuo Ueda stated that Takaichi did not make any specific requests during their routine meeting on Monday to discuss the economy and exchange general views. One of the BOJ's most hawkish members suggested last week that conditions for the next rate hike could be in place by spring.

However, following data showing Japan's economic output for the fourth quarter of 2025 was significantly weaker than expected, the probability of a rate hike by April—as implied by overnight index swaps—declined to approximately 65% from around 73% on Friday.

Regarding the five-year bond auction, Kazuya Fujiwara, Fixed Income Strategist at Mitsubishi UFJ Morgan Stanley Securities, noted, "The results were slightly soft but still within a range that can be considered safe." He added, "Given rate-hike expectations, market participants likely remain cautious, aware that five-year yields still have room to rise."

Strategist Mark Cranfield stated, "The data from the five-year JGB auction was sufficient to satisfy long-term investors, especially considering the middle part of the yield curve had frequently been targeted by aggressive short sellers. Although the bid-to-cover ratio was below the one-year average, it remained above 3.0. However, the fact that about 57% of the bonds were acquired by 'anonymous buyers' may raise some concerns about secondary market liquidity."

In her first post-election press conference, Prime Minister Takaichi acknowledged market skepticism about how she plans to increase spending on defense and strategic industries while achieving a reduction in the food consumption tax within two years. Finance Minister Satsuki Katayama clarified that the proposed consumption tax cut would be limited to two years and apply only to food items, adding that it would not rely on additional debt issuance.

Later this week, investors will also focus on the 20-year bond auction to gauge demand for super-long-term bonds against the backdrop of persistent fiscal concerns.