Bloomberg News

Intervention Failure Adds Pressure for BOJ Easing: Japan Credit

September 01, 2011

Sept. 2 (Bloomberg) -- The yen’s third monthly gain against the dollar means the Bank of Japan may decide next week to boost injections of funds into the financial system, as policy members seek ways to stem the currency’s strength and spur growth.

The BOJ has eased policy at least five times since December 2009, all following yen advances in the prior month. The yen posted a 0.1 percent gain versus the greenback last month and reached a post-World War II record of 75.95 per dollar on Aug. 19 even as Japan conducted its biggest currency-market intervention in seven years. The BOJ’s key interest rate is the lowest in the world at a range of zero and 0.1 percent, and hasn’t been above 0.5 percent since 1995.

A report this week showing a slowdown in Japanese factory output was the latest sign that the yen’s strength is impeding economic recovery from three quarters of contraction. Net exports, or shipments less imports, in the second quarter were the biggest drag on gross domestic product since 2009. The Bank of Japan will hold a two-day policy meeting on Sept. 6, ahead of a Federal Reserve gathering that starts Sept. 20.

“Because there’s no doubt the most serious risk to Japan’s economy comes from foreign exchange, we can say it’s the biggest deciding factor for BOJ policy,” said Chotaro Morita, chief rates strategist in Tokyo at Barclays Capital Japan Ltd., one of the 25 primary dealers obliged to bid at government debt sales. “Additional easing must be in the BOJ’s sight, given monetary policy in the U.S. may put further appreciation pressure on the yen.”

Asset Purchase

The BOJ said on Aug. 4 it was doubling the amount of government debt it buys through its asset-purchase program and the same day intervened in the foreign-exchange market for a third time in a year. The yen weakened to 80.24 per dollar on that day before erasing all the losses in the next three days.

Japan sold 4.51 trillion yen ($59 billion) in August, a statement from the Ministry of Finance showed this week, the largest monthly amount since March 2004. Yoshihiko Noda, who has succeeded Naoto Kan as prime minister, oversaw the operations as finance minister.

Demand for safer assets increased last month amid concern the U.S. recovery is faltering and Europe’s debt crisis is worsening. Yields on 10-year government debt slid to a record 1.9735 percent in the U.S. and a nine-month low of 0.97 percent in Japan on Aug. 19, while the MSCI World Index for stocks slumped 7.3 percent for the month, the most since May 2010.

Yield Spread

The yen tends to strengthen during periods of financial stress because Japan’s export-reliant economy doesn’t need foreign capital to balance its current account, the broadest measure of trade. A stronger currency reduces the overseas competitiveness of Japanese companies, and cuts the value of foreign earnings when repatriated.

The extra yield investors demand to own Japanese corporate bonds instead of similar-maturity government debt is 66 basis points, down from this year’s peak of 78 basis points on June 10, according to Nomura Securities Co.’s Bond Performance Index.

The extra yield investors demand to hold two-year Treasuries instead of the Japanese equivalent slid to three basis points yesterday, the least since 1992, diminishing the appeal of dollar-denominated assets.

BOJ Governor Masaaki Shirakawa said on Aug. 4 that there is a “relatively high” correlation between the two-year yield gap and the dollar-yen rate.

The BOJ currently buys Japan’s bonds with remaining maturities of between one and two years through its asset- purchase fund. Barclays’ Morita said the central bank may increase the amount of bond purchases or buy longer-maturity debt.

‘More Substantial’

A few Fed policy makers favored more aggressive action to stimulate the U.S. economy, minutes of their Aug. 9 meeting showed this week. Those members, who weren’t identified, “felt that recent economic developments justified a more substantial move” beyond the pledge adopted last month to hold its key interest rate at a record low until mid-2013.

U.S. GDP grew at a 1 percent annual pace in the April-to- June quarter, down from the 1.3 percent previously reported, the Commerce Department data showed last week.

“The Fed will do something for sure in September to bolster the economy, which will lead to further weakness in the dollar,” said Tsutomu Soma, a bond and currency dealer in Tokyo at Okasan Securities Co., another primary dealer. “We can increase dollar shorts against the yen without any fear in this environment.”

‘Real’ Threat

Japan’s benchmark 10-year bonds yielded 1.07 percent today, 10 basis points from the lowest level since Nov. 9, amid evidence the economy is struggling to recover from a record earthquake in March that triggered meltdowns at a nuclear facility and nationwide energy shortages. Industrial production gained 0.6 percent in July from the previous month, the slowest increase since March, the Trade Ministry said on Aug. 31.

“There is a real threat of a double-dip recession to the global economy,” bolstering demand for bonds, said Daisuke Uno, Tokyo-based chief strategist at Sumitomo Mitsui Banking Corp., which manages $964 billion in customer deposits.

Credit-default swaps insuring Japan’s sovereign debt for five years climbed to 113 basis points on Aug. 24, the highest since March 16, according to New York-based CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. They were at 102.3 basis points yesterday.

The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

--Editors: Patrick Chu, Nate Hosoda

To contact the reporters on this story: Masaki Kondo in Singapore at mkondo3@bloomberg.net; Monami Yui in Tokyo at myui1@bloomberg.net; Shigeki Nozawa in Tokyo at snozawa1@bloomberg.net

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


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