Bloomberg News

Narrowing Yield Curve Signals Deepening Recession: Japan Credit

September 20, 2011

Sept. 20 (Bloomberg) -- Investors have pushed yields on Japan’s 10-year bonds to the lowest since November relative to five-year notes, signaling increasing concern about the world’s third-largest economy’s ability to emerge from recession.

The gap shrank to 65 basis points today, from this year’s high of 79 basis points in April, after data this month showed that Japan’s economy contracted in the second quarter by more than initially reported. The yield difference, which narrows as investors accept less in compensation to own long-term debt on expectations growth won’t be strong enough to spark inflation, compares with 110 basis points in the U.S.

So-called yield curves are shrinking all around the world as reports on everything from consumer confidence to manufacturing signal that the global economy is decelerating. On Sept. 8 the Organization for Economic Cooperation and Development said Japan’s economy will expand 4.1 percent this quarter before stalling in the fourth.

“Japan’s bonds are pricing in another slowdown and recession, judging from narrowing gaps between short- and long- term yields in the U.S. and elsewhere,” said Hitoshi Asaoka, a senior strategist in Tokyo at Mizuho Trust & Banking Co., a unit of Japan’s third-largest banking group. “Long-term yields are not only reflecting expectations for further monetary easing, but also a global economic slowdown.”

Relative Yields

Japan’s benchmark 10-year yield declined two basis points to 0.985 percent today, after reaching 0.97 percent on Aug. 19, the lowest since Nov. 9. That compares with 1.94 percent in the U.S. and 1.8 percent in Germany. Japan’s five-year bond yield was at 0.335 percent.

Credit-default swaps protecting Japan’s debt from losses for five years climbed to a record 123 basis points on Sept. 13, CMA prices in New York showed. CMA is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Japan’s gross domestic product shrank at an annualized 2.1 percent rate in the three months ended June 30, the Cabinet Office said on Sept. 9. That was more than the 1.3 percent contraction initially reported last month for a nation reeling from a strong yen, a record earthquake in March and an ongoing nuclear disaster.

Stocks Drop

The Nikkei 225 Stock Average closed at 8,518.57 yen on Sept. 14, the lowest close since April 2009. The price of shares on the average slid to 1.13 times book value, near the least since April 2009.

Global growth concerns have boosted demand for safer assets, with Japan’s sovereign debt maturing in 10 years or longer returning 0.6 percent in August, the fifth-consecutive monthly gain, according to a Bank of America Merrill Lynch index. The Nikkei 225 plunged 8.9 percent in its steepest monthly slide since May 2010.

“A prolonged slump in the global economy will certainly damage Japanese companies’ earnings for a long time,” said Hiroshi Fujimoto, a fund manager at Tokyo-based Shinkin Asset Management Co., which oversees the equivalent of $3.9 billion. “That’s why investors are unwilling to buy stocks despite cheap valuations.”

Overseas investors, who accounted for 69 percent of Japan’s stock trading by value in August, sold a net 1.07 trillion yen ($14 billion) of shares during the month, according to data released by the Tokyo Stock Exchange on Sept. 9. It was the fourth-most on record and the first net sale in a year.

Reconstruction Benefits

“Japan’s economy isn’t in as bad a situation as Europe and the U.S.,” said Kiyoshi Ishigane, a senior strategist in Tokyo at Mitsubishi UFJ Asset Management Co., a unit of Japan’s biggest bank by market value. “Sooner or later, reconstruction efforts will create demand and boost the economy, which gives upward pressure to bond yields.”

Ten-year bond yields may rise to 1.2 percent by the end of March, while the Nikkei 225 may advance to as high as 10,000, Ishigane said.

U.S. Federal Reserve policy makers will start a two-day policy meeting today after Chairman Ben S. Bernanke said last month that the central bank still has stimulus tools without providing details or committing to deploying them.

European Central Bank President Jean-Claude Trichet said Sept. 8 that risks to the economic outlook in the 17-member euro zone are on the downside. The ECB said Sept. 15 that it and other central banks will coordinate to lend dollars to euro-area banks, easing liquidity concerns amid the region’s debt crisis.

Italy’s credit rating was cut by Standard & Poor’s on concern that weakening economic growth and a “fragile” government mean the nation won’t be able to reduce the euro- region’s second-largest debt burden. The rating was lowered to A from A+, with a negative outlook, S&P said in a statement dated yesterday.

Rising Yen

The yen has gained against all of its 16 major counterparts over the past three months. It reached 75.95 per dollar on Aug. 19, a post-war high, and touched 103.90 per euro on Sept. 12, the strongest since June 2001. An appreciating yen hurts exporters because it reduces the value of overseas income.

At its meeting on Sept. 7, the Bank of Japan kept monetary policy unchanged, after adding 10 trillion yen of stimulus last month. BOJ board member Ryuzo Miyao said the central bank is ready to take “appropriate” action as needed to support the economy amid worries that the yen will stay strong.

Participants in Japan’s bond market expect yields on government securities to remain stable at low levels, a senior Ministry of Finance official said Sept. 16 after meetings with the nation’s 24 primary dealers.

Third Package

Primary dealers said investors will continue to avoid taking risks amid uncertainty over the U.S. economy and sovereign-debt woes in Europe, the official, who spoke on condition of anonymity, told reporters in Tokyo. Participants said investors will be watching developments in Japan’s compilation of its third extra budget for reconstruction.

Prime Minister Yoshihiko Noda, who previously served as finance minister, said the government will compile a third post- disaster stimulus package to spur growth and enhances fiscal discipline on the world’s biggest debt burden. The premier also indicated taxes may need to be raised to help fund the initiatives.

Since the March 11 earthquake, the central bank has done everything from bolstering asset-programs to increasing liquidity provisions to bolster growth. Bank of Japan board member Sayuri Shirai said last week that that she hasn’t ruled out any monetary stimulus tools.

“We added 10 trillion yen in August and we’ll implement that through the end of next year,” said Shirai, a former Keio University economics professor who joined the board in April, referring to expansions to the bank’s asset-buying fund and credit program taken on Aug. 4, the day the government sold the yen to stem its advance. “That means we’re still in the middle of rolling out our monetary stimulus. We expect to continue to see the effect of that easing.”

--With assistance from Aki Ito and Masahiro Hidaka in Tokyo. Editors: Patrick Chu, Garfield Reynolds

To contact the reporters on this story: Yoshiaki Nohara in Tokyo at; Satoshi Kawano in Tokyo at; Masaki Kondo in Singapore at

To contact the editors responsible for this story: Nick Gentle at; Rocky Swift at

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