Investors, drawn by higher yields, have shown the strongest demand for Japan's 40-year government bond auction since March 2025. The bid-to-cover ratio for Wednesday's auction was 2.82, up from 2.702 at the prior auction and above the 12-month average of 2.55. Following the sale, Japanese government bond prices remained largely steady. Recent comments from Japanese government officials, emphasizing the importance of the Government Pension Investment Fund increasing its investment in domestic financial assets, have provided support for bond prices. The yield on Japan's 40-year bond, after reaching a record high of 4.355% in May, is currently fluctuating around 3.91%.

There are signs of strength in Japan's sovereign debt, with last week's 20-year bond auction seeing a bid-to-cover ratio close to the seven-year high touched in April. Finance Minister Tsuyoshi Katayama has also suggested the idea of including government bonds in the tax-exempt Nippon Individual Savings Account (NISA) program.

"The solid 40-year auction following the strong 20-year auction shows that ultra-long bonds are performing well even as mid- to long-term yields continue to rise," said Miki Den, a senior rates strategist at SMBC Nikko Securities. "Ultra-long bond yields are likely to stay around current levels."

Last month, Japanese insurance companies purchased the largest amount of ultra-long government bonds in three years, further indicating that demand from major buyers is stabilizing. Meiji Yasuda Life Insurance Company stated it may increase its holdings of Japanese ultra-long government bonds by up to 1 trillion yen (approximately $6.1 billion) in the fiscal year 2026.

"Today's Japanese 40-year bond auction attracted the strongest demand since March 2025, with the highest yield slightly below pre-auction polling data, but still not enough to ensure good performance in the secondary market," said strategist Mark Cranfield. "Investors will soon seek yields above 4%, as there seems to be no sign of a reversal in the yen's recent weakness. This makes Japanese government bonds vulnerable to a negative feedback loop from yen depreciation."

Some investors remain focused on Prime Minister Sanae Takaichi's expansionary fiscal policy, expectations for the Bank of Japan's gradual interest rate tightening, and the still-large interest rate differential. The Takaichi government on Tuesday approved an annual economic and fiscal policy plan that emphasizes central bank independence, but the costly issue of a significant food consumption tax cut remains unresolved.

Notably, affected by renewed escalation in US-Iran tensions pushing up oil prices, the yen's exchange rate against the US dollar overnight briefly fell below the 163 mark for the first time since 1986. The persistent weakness of the yen is raising import costs, further amplifying domestic inflationary pressures in Japan. Despite the Bank of Japan raising its benchmark interest rate last month to its highest level since 1995, investors remain concerned that its pace of rate hikes is insufficient to curb inflation. The Bank of Japan will hold a policy meeting next week, with market consensus expecting it to keep the policy rate unchanged at 1.0%. The central bank finds itself in a difficult position, caught between supporting the currency, stabilizing public finances, and controlling inflation, leaving it with very limited room for policy maneuver.