Bloomberg News

Bond Risk Narrows on U.S. Impasse, Supports JGBs: Japan Credit

August 01, 2011

Aug. 1 (Bloomberg) -- Japanese government bond risk has dropped to the lowest this year relative to Treasuries as prospects for a U.S. default countered concern the Asian nation will be unable to tackle the world’s largest debt.

Contracts to insure Japan’s debt against default traded at 90.9 basis points on July 29, narrowing the spread with the U.S. to 28.9 basis points, near the least since Dec. 1, according to CMA prices in New York. Investors outside the U.S. own about half of all outstanding Treasuries, while about 95 percent of Japanese government bonds are held domestically.

Japan’s bond market has weathered rating cuts and threats of further demotions while the U.S. risked a downgrade as lawmakers wrangled over plans to raise the debt ceiling and cut spending. Domestic demand has helped Japan preserve the world’s lowest bond yields, while the yen’s gain toward record levels makes the debt attractive to China and other overseas investors.

“Japan has experienced downgrades while a rating cut for U.S. debt would be new and draw the market’s attention,” said Satoshi Yamada, who helps oversee about $13 billion as manager of fixed-income trading at Okasan Asset Management Co. in Tokyo. “Japanese government bonds are in a much better position, judging from good supply demand conditions. The bias is for money to flow into JGBs in terms of currency moves.”

President Barack Obama said late yesterday that leaders of both parties in the U.S. House and Senate had approved an agreement to raise the $14.3 trillion debt ceiling. His announcement came after Republican and Democratic lawmakers stretched negotiations into the weekend on increasing the cap an cutting spending.

Treasury Secretary Timothy F. Geithner has said the U.S. would run out of options to prevent a default by tomorrow if the limit isn’t boosted.

Trade Surplus

Five-year credit-default swaps on U.S. debt climbed to 64.4 basis points on July 28, the highest since March 2009 and up from 41.5 points at the end of 2010, according to data by CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The U.S. contracts were last at 62.1 basis points, compared with 1,700 basis points for Greece and 86.9 basis points for China.

Japan’s default swaps have fallen from the 117.75 basis- point peak in the days following a record earthquake in March. While the nation has a public debt burden that’s twice as big as its economy, Japan’s trade surplus frees it from reliance on foreign capital to plug its budget deficit. The current-account surplus was 590.7 billion yen ($7.59 billion) in May, the government said last month.

‘No Means Good’

“Japan is by no means good,” said Akane Enatsu, a senior credit analyst at Barclays Capital in Tokyo, speaking in a telephone interview. “The fiscal deficit and liabilities are surprising numbers, but there’s surplus in the current account, and Japan can manage its finance on its own.”

Standard & Poor’s, which has given the U.S. a AAA rating since 1941, said on July 14 the chance of a downgrade is 50 percent in the next three months and it may cut the ranking as soon as August if there isn’t a “credible” plan to reduce the deficit. Moody’s Investors Service and Fitch Ratings have also said they may lower the top-level sovereign ranking if officials fail to resolve the stalemate.

S&P hasn’t rated Japan AAA since 2001 and downgraded the country in January for the first time in almost nine years, cutting the ranking to AA-. Moody’s and Fitch said in May they may also reduce Japan’s credit rating.

Yen’s Strength

The yen has gained 4.1 percent in the past three months, according to Bloomberg Correlation-Weighted Currency Indexes, as the U.S. debt ceiling issue boosted demand for a refuge. That’s the third best performance behind the Swiss franc’s 9.4 percent gain and the New Zealand dollar’s 9.3 percent surge. The greenback has lost 0.7 percent.

“The U.S. debt-ceiling issue is a selling catalyst for the dollar,” said Makoto Noji, a senior bond and currency strategist in Tokyo at SMBC Nikko Securities Inc. “Yen- denominated assets are considered as relatively safe.”

The yen’s strength has increased returns from Japan’s government bonds although their yields are the lowest among the 32 markets tracked by Bloomberg. The securities have returned 6.4 percent for the past three months to investors who converted their proceeds into dollars, compared with 3.1 percent from Treasuries, according to indexes compiled by Bank of America Merrill Lynch.

Ministry of Finance data show 95 percent of Japan’s bonds are owned by domestic investors, with banks making up 45 percent. Overseas investors accounted for 48 percent of U.S. debt holders, according to Treasury data. The U.S.’s dependence on foreign funds makes its bonds relatively more vulnerable to sell-offs, Nikko’s Noji said.

“If there’s a question over the U.S.’s creditworthiness, overseas investors will favor their own domestic currencies and bonds,” he said. “There’s ample domestic funds to absorb Japanese government bonds even if the foreign investors sell.”

--With assistance from Yusuke Miyazawa in Tokyo and Wes Goodman in Singapore. Editors: Rocky Swift, Nicholas Reynolds

To contact the reporters on this story: Yoshiaki Nohara in Tokyo at ynohara1@bloomberg.net; Masaki Kondo in Singapore at mkondo3@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net


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