Japan's Ministry of Finance sold 1.9719 trillion yen of 10-year government bonds on Thursday, Nov. 5, at an average yield of 2.768%, a third of a percentage point below last month's sale, but demand was thinner and the auction priced with a much wider tail than in October, ministry data showed.

The same morning, the Bank of Japan published minutes of its Sept. 17-18 meeting, where it raised its policy rate to 1.25%. They show board members debating how far rates can rise and warning against markets pricing in too much tightening. For investors in Asia who hold Japanese debt, or who fund positions in yen, the two releases together frame the question that sets JGB prices: how high the BOJ is prepared to go, and whether buyers will absorb a heavy supply of bonds at current yields.

Weaker cover, wider tail at the 10-year sale

The Nov. 5 auction reopened the 10-year bond No. 384, which carries a 3.1% coupon and matures on Sept. 20, 2036. Competitive bids totaled 6.3355 trillion yen against 1.9719 trillion yen accepted, a ratio of about 3.2 times by Capital Times' calculation. At the Oct. 6 auction of the same issue, bids of 7.4011 trillion yen covered 1.9661 trillion yen accepted, about 3.8 times.

The tail, the gap between the average price and the lowest price the ministry accepted, also widened. On Thursday the average price was 102.57 yen per 100 yen of face value and the lowest accepted price was 102.32 yen, a difference of 0.25 yen. In October the gap was 0.02 yen (99.99 against 99.97). The yield at the lowest accepted price was 2.800%, against 3.103% a month earlier.

Primary dealers, known as JGB Market Special Participants, took a further 243.9 billion yen in a second non-price-competitive round after the main sale, according to a separate ministry release. Non-competitive bids added 1.226 billion yen.

Thursday's sale came at much lower yields than October's because the market has rallied since early last month. Ministry of Finance reference data put the 10-year yield at 3.103% on Oct. 6, the day of the previous auction, and at 2.817% on Oct. 30. The yield stood at 2.855% at the Nov. 4 fixing, the latest the ministry had published by Thursday evening, with the 30-year yield at 3.979%. The 2.800% yield at the lowest accepted price sat below that Nov. 4 level. Capital Times reported last week that the 10-year yield ended October below 2.8% after the BOJ left rates unchanged.

BOJ minutes: a 7-2 hike and a debate over the neutral rate

The minutes cover the meeting at which the board voted 7-2 to lift the overnight call rate target to around 1.25%. Toichiro Asada and Ayano Sato dissented. Asada argued that with core consumer inflation running below 2% the economy could not necessarily be called strong, the minutes said. Sato said economic and price developments did not appear to have accelerated substantially.

The longest discussion concerned the neutral interest rate, the level that neither stimulates nor restrains the economy. A few members noted that market estimates of the neutral rate and of the terminal policy rate had risen. One said the two-year forward one-year rate in the overnight index swap market, a gauge of where traders expect the BOJ to stop, had recently exceeded 2%, while cautioning that the measure swings with many factors, including overseas rates.

Another member said market expectations for rate increases looked "somewhat ahead" of Japan's economic and price conditions. Many members agreed that the neutral rate was difficult to identify in advance and that the bank should keep adjusting policy while watching how the economy responds to each move. One member called for effective communication to stop one-sided policy expectations from being priced into markets.

The minutes also said 10-year JGB yields had risen in the period before the September meeting, moving with U.S. rates as investors raised their terminal-rate expectations, and that liquidity indicators in the JGB market had kept improving. The bank was buying about 2.5 trillion yen of JGBs a month under the purchase plan set in June.

Government representatives attending the meeting asked the BOJ to explain its decision carefully to markets. The Cabinet Office representative said the bank should examine the cumulative effects of past rate increases and might need to take its estimates of the neutral rate into account.

What comes next for JGB investors

Since September the BOJ has held its rate at 1.25%, voting 8-1 at its October meeting while raising its inflation forecast. The September minutes suggest a board that sees more room to raise rates but wants to avoid giving markets a fixed destination.

The ministry's reference yield for Thursday's session will show whether the auction's 2.800% clearing level held in the secondary market. The BOJ's December policy meeting is the next test of how far the board's caution on the neutral rate restrains long-term yields.