Deficit Panic, Japan Treasury Auctions and Questions on Terminology
James Keenan
For reasons that are partially masochistic, I've been reading about the latest round of Deficit Panic. This round has been mainly touched off by the huge gap between tax revenues and planned spending in the Republican "Big Beautiful Bill" making its way through the U.S. Congress. In the financial press, however, there's also a fair amount of Deficit Panic with respect to Japan. Demand for Japanese Treasury bonds at a recent auction was characterized as weak. A May 28 New York Times article ("Japan’s Debt, Now Twice the Size of Its Economy, Forces Hard Choices") stated:
"Recently, the market for Japanese government bonds has reflected concern about the country’s fiscal health. The yields on long-term bonds, an indication of investor confidence in the government’s ability to pay back its debts, rose to record highs at one point last week. And weaker-than-expected demand for an auction of 40-year bonds on Wednesday kept investors on edge. " [Emphasis added.]
"Japan’s prime minister, Shigeru Ishiba, warned at a recent government meeting about the “terror” of higher interest rates and even compared Japan’s budget situation to that of Greece, which plunged into a debt crisis in 2009."[1]
The article's authors then go on to recite standard deficit dogma:
"Generally, excessive debt can push economies into a perilous cycle. Bondholders grow increasingly apprehensive about a government’s ability to pay its obligations, which drives up interest rates. Escalating rates then ripple through an economy, impeding a nation’s capacity to borrow."
MMT advocates would argue that these "apprehensions" are groundless. Japan is, for all practical purposes, a monetarily sovereign nation. The Japanese government sells debt instruments in a currency, the yen, which the government itself issues. Hence all payments of principal or interest on Japanese treasuries can always be made. The Japanese government cannot be forced into default on its obligations. The value of the yen is not tied to gold or to any other currency. Japan, perhaps more than any other country, has a demonstrated history of managing both short- and long-term interest rates.
If, however, the holders of Japanese bonds choose to ignore the findings of MMT, then they're free to become apprehensive about Japanese bonds for any reason they please.
That being said, I wasn't satisfied with the Times article and decided to seek out other sources. The Washington Post had nothing to say. Other sources like the Financial Times, Bloomberg, etc., did have articles but they were paywalled. I came across a May 20 article at a site called TradingKey: U.S. Treasuries Weather Downgrade Fears, but Japanese Bonds Collapse — Is the Yen About to Crash?, in which I read:
"While global investors are still assessing the implications of the U.S. losing its last AAA sovereign credit rating, a bond auction in Japan collapsed unexpectedly, potentially marking a turning point for the Bank of Japan’s (BoJ) tightening cycle — and raising concerns about an imminent yen collapse.
"On Tuesday, May 20, the Japanese Ministry of Finance held a ¥1 trillion auction for 20-year government bonds, which ended in disaster:
"* The bid-to-cover ratio dropped from 2.96x in April to just 2.5x, the lowest since 2012.
"* The tail spread — a key indicator of demand weakness — surged to 1.14 basis points, the highest level since 198 [sic], signaling weak investor appetite."
Some Specific Questions
Some questions about the terminology used in that TradingKey article ...
Investopedia explains "bid-to-cover ratio" like this:
"* The bid-to-cover ratio is the dollar amount of bids received in a Treasury security auction versus the amount sold.
"* The bid-to-cover ratio is an indicator of the demand for Treasury securities; a high ratio is an indication of strong demand."
So, am I correct in thinking that, notwithstanding the drop in the bid-to-cover ratio at the May 20 Japanese Treasury auction, all the bonds offered for sale were actually sold (albeit perhaps at a lower price than anticipated)?
If so, isn't it an exaggeration to say that that bond auction "collapsed"?
Now, as to "tail spread" ... I found many explanations of "tail risk" (e.g., Wikipedia), but few for the exact phrase "tail spread." Can anyone explain what that means in the context quoted above?
Warren Mosler
If so, isn't it an exaggeration to say that that bond auction "collapsed"?
***Yes, ridiculously so in fact.
Now, as to "tail spread" ... I found many explanations of "tail risk" (e.g., Wikipedia), but few for the exact phrase "tail spread." Can anyone explain what that means in the context quoted above?
It's the spread between the average yield assigned to the auction winners and the lowest bid that was included in determining the average.
I'd call the spread 'less trivial than expected'
;)
It's all alarmist nonsense, as always.
Warren
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Brian Flaherty
- My understanding of primary dealer systems (like the US and Japan have) is that they are a backstop to ensure that bid-to-cover ratios will never fall below 1. This means that it's impossible for an auction to 'fail' in the classic sense. It's frustrating for journalists to not acknowledge this.
- With that said, auctions could 'fail' if bid prices are abnormally low (possibly due to higher anticipated inflation resulting in higher expected future CB rates). But this can always be fixed by a CB committing to keeping long-term rates pegged.
- I'd have to do some more research but I'd speculate that weak demand for long-dated JGBs can be easily explained by investors not wanting to take on high duration risk with expectations of continuing rising rates (as the BOJ unwinds its balance sheet). This is a much different story than deficit panic.
Jay Mills
Primary dealers must bid at auction. This ensures bid-to-cover ratios (total bids/total offered bonds) stay above 1, effectively preventing a “failed auction” in the conventional sense.
o Misleading narrative: Media sometimes implies auctions can “fail” like corporate debt offerings might, which is structurally not accurate for sovereigns like Japan or the U.S.
2. Yield Movement vs. Auction Success
Even if there is low demand at favorable prices (i.e., low yields), the auction still “clears” by adjusting yields upward.
o What’s really happening: High yields (low prices) reflect market expectations about:
§ Future interest rates
§ Inflation
Your speculation aligns well with what’s likely happening:
Duration risk aversion: Long-term JGBs (e.g., 20-year, 30-year) are highly sensitive to interest rate movements. If market participants believe the Bank of Japan (BOJ) will continue tightening policy or allow long-term rates to rise, they avoid locking in low yields for decades.
BOJ Balance Sheet Unwind: With the BOJ moving away from yield curve control (YCC) and asset purchases, investors may expect less artificial demand for long-term JGBs—meaning yields will rise to reflect more “natural” supply/demand dynamics.
Bloomberg and others sometimes imply that weak demand is a fiscal problem, which echoes outdated fears of deficit-driven bond market rebellion. In reality:
Japan has run massive deficits and debt-to-GDP >250% for years with near-zero interest rates.
What moves the bond market short-term is central bank policy guidance and investor positioning—not debt size alone.
Best,
Jason