Bloomberg News

Yen Bond Yield Gap to Foreign Debt at Record Low: Japan Credit

October 11, 2011

Oct. 11 (Bloomberg) -- The difference in yields between Japanese government bonds and those sold by other nations has shrunk to the least on record, curtailing demand for foreign debt among the Asian nation’s money managers.

An index of yen bonds yields about 100 basis points less than a gauge of government securities worldwide, the least based on monthly data from Bank of America Merrill Lynch going back to 1996. The extra yield investors get for buying 10-year Treasuries instead of same-maturity Japanese bonds narrowed to 74 basis points last month. The gap to German rates shrank to 69 basis points. Both spreads were the least in two decades.

A global economic slowdown that’s spreading to Asia gives investors extra reason to favor Japan’s bonds. The world’s third-biggest economy will shrink 0.6 percent this year, Naohiko Baba, the chief economist for Goldman Sachs Group Inc. in Tokyo, wrote in an Oct. 4 report. U.S. gross domestic product will expand 1.7 percent and Europe’s 1.6 percent, according to the firm, one of the 25 primary dealers that underwrite Japan’s government debt.

“I’m bullish on Japanese government bonds,” said Chiyuki Takamatsu, an investor at Fukoku Mutual Life Insurance Co. in Tokyo, which has the equivalent of $71.7 billion in assets. “The risks to the Japanese economy are increasing. From a Japanese investor’s perspective, U.S. Treasuries and German bonds are no longer attractive.”

Yield Forecasts

Goldman Sachs reduced its six-month prediction for Japan’s 10-year yields to 1.2 percent from 1.3 percent and trimmed its call for U.S. rates to 2.25 percent from 3 percent. It lowered the outlook for German yields to 2 percent from 2.75 percent.

Japan’s 10-year note yielded 0.99 percent as of 12:54 p.m. in Tokyo, after falling to this year’s low of 0.965 percent on Sept. 22. Yields on similar-maturity bonds fell to records of 1.6714 percent in the U.S. and 1.636 percent in Germany on Sept. 23.

The Asian nation’s securities lagged behind peers during the rally. Yen debt returned 1.6 percent in three months ended Oct. 7, compared with 5.7 percent for Treasuries and 6.6 percent for bunds, the Bank of America figures show.

Investors sought government debt as stocks tumbled, sending the MSCI All Country World Index of shares down 17 percent in the same period, after accounting for reinvested dividends, according to data compiled by Bloomberg.

Auction Demand

Japan’s sale of 20-year debt on Sept. 13 drew bids for 3.39 times the amount of bonds available, the most since May, and the last 30-year auction on Sept. 6 drew a higher price than traders expected. The government is scheduled to sell 30-year bonds on Oct. 13 and 20-year debt on Oct. 20.

Japan is America’s second-largest overseas creditor after China, holding $914.8 billion of U.S. debt as of July. It trimmed its position in April and June, the first net sales since May 2010, Treasury Department data show.

More recent Federal Reserve figures show central banks outside the U.S. cut their investment in Treasuries to $2.7 trillion as of Oct. 5 from a record $2.76 trillion in August. Foreign central banks have sold U.S. debt for six weeks, the longest run since 2001.

The narrower spreads between domestic and overseas debt means Japanese investors don’t get as much protection against possible currency losses when they buy bonds abroad.

Foreign-Exchange Risk

“The attractiveness of overseas bonds has declined,” said Shuntaro Take, the deputy general manager in Tokyo for corporate investment at Tokio Marine & Nichido Life Insurance Co., which manages the equivalent of $49 billion. “Yields aren’t sufficient to take foreign-exchange risk.”

Tokio Marine is favoring debt due in 20 years and longer, according to Take. Fukoku bought 20-year Japanese bonds in April and added to the position in September, said Yoshiyuki Suzuki, the company’s head of fixed income in Tokyo.

The yen rallied 5.1 percent against the dollar in the past three months, the only one of the 16 most-traded currencies to gain, according to data compiled by Bloomberg. It strengthened to a post World War II record of 75.95 against the dollar on Aug. 19 from 85.53, its weakest level this year set in April.

A dollar-based investor in yen bonds earned 5.9 percent in the third quarter after accounting for changes in the currency, the most since the July-to-September period of 2010.

Insurers Buying

Demand from insurers will help cap Japanese bond yields, Mitsubishi UFJ Morgan Stanley, another primary dealer, said in a report Oct. 3.

“Life insurers may fundamentally rethink their asset allocation strategies, reducing the percentage of foreign bonds in their portfolios and increasing the percentage of yen bonds,” wrote Jun Ishii, the company’s Tokyo-based chief fixed income strategist.

Insurers had 371.3 trillion yen ($4.8 trillion) of assets at the end of June, more than investment companies and pension funds combined, according to the Bank of Japan. Almost 60 percent of the holdings were in bonds, the figures show.

The spread between rates on Japan five-year government bonds and inflation-linked securities, a gauge of trader expectations for consumer prices over the life of the debt, was negative 35 basis points, after touching negative 68 basis points in March, the biggest spread this year.

The extra yield investors demand to own Japanese corporate debt instead of similar-maturity government bonds has narrowed to 71 basis points from 78 basis points in June, according to Nomura Research Institute Ltd. The average for 2011 is 56 basis points, or 0.56 percentage point.

Credit-default swaps insuring Japan’s sovereign debt for five years have fallen to 1.24 percentage points from a record 1.55 percentage points on Oct. 4, according to New York-based CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

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.

--With assistance from Naoto Hosoda in Tokyo and Masaki Kondo in Singapore. Editors: Garfield Reynolds, Naoto Hosoda

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@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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