Bloomberg News

Swap Spread at 5-Month High as Europe Boosts JGBs: Japan Credit

July 13, 2011

July 14 (Bloomberg) -- Swaps are signaling that Europe’s debt crisis is causing Japan’s credit markets to tighten, driving a barometer of risk to the highest level in five months.

The difference between two-year interest-rate swaps and yields on similar maturity government notes this week reached 23 basis points, or 0.23 percentage point, the most since February. Ireland’s credit rating was cut to below investment grade by Moody’s Investors Service on July 12, following downgrades to Portugal and Greece to so-called junk status.

Europe’s debt woes have also boosted demand for the yen as a refuge, sending it to the highest in almost four months against the dollar and euro. A stronger yen threatens to derail Japan’s export-driven recovery from a record earthquake and adds to deflationary pressures that support government bonds.

“We are seeing a flight to quality, and the two-year swap spread reflects credit risk,” said Reiko Tokukatsu, a senior fixed-income strategist at Barclays Capital Japan Ltd. “Europe’s debt crisis is causing risk aversion and making it easier for short-term government debt to be bought.”

The two-year Japanese swap rate was at 0.38 percent on July 12, while the yield on the straight bond reached as low as 0.147 percent, close to this year’s low. The gap was 22 basis points today.

Swaps are susceptible to credit risk because their payments are affected by changes in the London Interbank Offered Rate, a global benchmark for lending. The two-year euro swap spread on July 11 widened to about 73 basis points, the highest since January. The dollar swap spread has gained to about 28 basis points from 25 basis points on July 8.

Libor Rates

The Libor rate for six-month loans in yen stood at 0.340 percent yesterday, according to British Bankers’ Association. The dollar Libor rate was 0.413 percent, while the euro rate was 1.792 percent.

“Rates on interest-rate swaps are unlikely to fall, as people see a risk that Libor may climb, while it’s easier to buy JGBs as a refuge,” said Akito Fukunaga, chief rates strategist at the brokerage unit of Royal Bank of Scotland Plc in Tokyo. “Investors need to consider what will happen if the crisis spreads to Italy and Spain.”

European Central Bank President Jean-Claude Trichet on July 10 said Europe is at the “epicenter” of a debt crisis that concerns the entire developed world. Yields on 10-year Italian debt climbed to the highest since 1997 this week amid concern a crisis that started in Greece is spreading to Europe’s largest borrower.

Rating Downgrades

Ten-year government bonds yield 1.085 percent in Japan, matching an eighth-month low. That compares with 16.98 percent in Greece, 14 percent in Ireland and 5.55 percent in Italy.

Downgrades by Moody’s and Standard & Poor’s have driven yields higher in Europe, while credit warnings in Japan have had comparatively little impact in Japan, where 95 percent of the government’s debt is held domestically.

Moody’s and Fitch Ratings said in May they may cut Japan’s credit rating, after Standard & Poor’s reduced the nation’s debt ranking in January for the first time in almost nine years. Tokyo-based Japan Credit Rating Agency Ltd. has maintained its top AAA credit for the nation.

“We believe that Japan still has financial flexibility, its current account surplus, massive household assets and room to raise taxes,” said Toshihiko Naito, a senior analyst at JCR.

The Markit iTraxx SovX Western Europe Index of swaps on 15 governments increased 66 basis points this month to 283 as of July 12. An increase signals deteriorating perceptions of credit quality. Five-year contracts to insure Japan’s government bonds against default rose 2.5 basis point to 93.4 basis points July 12, its highest level since April 1, according to data provider CMA prices in New York. The rate was 90.6 basis points yesterday.

Yen, Intervention

The yen reached 78.47 per dollar today, the strongest since March 17, when it surged to a postwar record of 76.25 per dollar. Group of Seven nations jointly intervened in the markets the next day to halt the currency’s gain. Japan’s currency touched 109.58 per euro on July 12, the highest since March 17.

One-month implied volatility for the dollar-yen exchange rate rose to 10.5, up from the more than three-year low of 8.1 on July 8. That’s still lower than the 16.9 level on March 17 that preceded the G-7’s coordinated intervention to combat what they called in a statement “excess volatility and disorderly movements in exchange rates.”

“The hurdle for joint intervention is high, which is supporting the yen,” said Tetsuya Miura, chief market analyst in Tokyo at Mizuho Securities Co., a unit of Japan’s second- largest banking group, wrote in a note yesterday. “People are feeling comfortable to buy the yen even after it rose past 80. It’s hard to sell JGBs under such circumstances.”

--With assistance from Yusuke Miyazawa, Rocky Swift and Toru Fujioka in Tokyo. Editors: Rocky Swift, Jonathan Annells

To contact the reporters on this story: Yoshiaki Nohara in Tokyo at; Saburo Funabiki in Tokyo at

To contact the editor responsible for this story: Rocky Swift at

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