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Steepest Swap Curve Showing Faith in Abe Inflation: Japan Credit

January 30, 2013

Prime Minister Shinzo Abe is starting to convince investors that he can stoke inflation, interest-rate swap contracts suggest.

The difference between costs to lock in borrowing for 30 years versus 10 years reached 1.24 percentage points on Jan. 25, the most in Bloomberg data going back to 1999 and higher than the U.S. spread of 0.94 percentage points. Japan’s inflation- linked bonds maturing in June 2018 climbed to an all-time high of 111.315 yen yesterday and indicated an average increase in consumer prices of 0.9 percent in the coming five years.

At Abe’s urging, the Bank of Japan (8301) last week doubled its inflation target to 2 percent and said it will start open-ended asset purchases next year. The Ministry of Finance this week announced that it will resume issuance of inflation-indexed bonds, known as linkers, after a four-year hiatus, adding a provision to protect investors in case deflation comes back.

“The markets are believing that Abe can make inflation happen,” Greg Gibbs, a Singapore-based senior currency strategist at Royal Bank of Scotland Group Plc, said yesterday. A steeper swap curve “would indicate that inflation expectations in Japan over the long term have increased more than in the U.S. recently, which would be consistent with the policy shift from the government in Japan.”

The yen dropped 11 percent last year versus the dollar, the biggest annual slide since 2005, as Abe called for unlimited money printing by the central bank to end deflation. It sank 0.6 percent to 91.23 per greenback as of 5:45 p.m. in Tokyo. A weaker yen typically raises import costs, helping boost consumer prices.

Open Ended

The BOJ will buy 10 trillion yen ($110 billion) of Japanese treasury bills and 2 trillion yen of government notes every month starting next year, the central bank said on Jan. 22. While it’s similar to the open-ended asset buying of the Federal Reserve, the BOJ’s program doesn’t increase indefinitely in size like that of its U.S. counterpart.

Japan’s consumer prices excluding fresh food have declined at an average of 0.2 percent every month over the past decade, while government debt handed investors 1.5 percent on an annualized basis during the period, according to an index compiled by Bank of America Merrill Lynch.

The so-called core inflation rate hasn’t been above 2 percent for more than a year since 1992. Consumer price gains will be 0.5 percent in fiscal 2013, the government said in revised estimates this week.

Woori, Nissan

Elsewhere in Japan’s credit markets, South Korea’s Woori Bank Co. sold a total of 30 billion yen in two-year and three- year Samurai bonds, SMBC Nikko Securities Inc. said in a statement yesterday. The securities offer a coupon of 0.77 percent and 0.87 percent respectively.

Nissan Financial Services Co. offered 30 billion yen of three-year, 0.271 percent notes, according to a statement yesterday from Mitsubishi UFJ Morgan Stanley Securities Co. The company issued similar-maturity debt in September with a coupon of 0.306 percent, data compiled by Bloomberg show.

Samurai notes, which are yen-denominated securities offered in Japan by overseas borrowers, have returned 0.2 percent this year, according to Bank of America Merrill Lynch data. Corporate debt in the country handed investors 0.23 percent, while company bonds worldwide lost 0.63 percent.

Five-year credit-default swaps show investors have to pay $75,000 to insure $10 million of Japan’s government bonds, according to CMA, a data provider owned by McGraw-Hill Cos. that compiles prices quoted by dealers in the privately negotiated market. It has averaged $72,011 in the past five years.

Deflation Impact

The Japanese government is scheduled to sell 2.7 trillion yen of two-year notes today. Last month’s auction of the bonds attracted bids valued at 9.73 times the amount available, the weakest demand in six months, Ministry of Finance data show.

Falling prices damp wages and encourage consumers to hoard cash rather than spend. More than half of Japanese household assets were cash and bank deposits, compared with 14 percent in the U.S. and 36 percent in the euro region, the latest report from the BOJ showed.

“Domestic investors aren’t expecting Japan’s deflation to end anytime soon,” Shinichi Horikawa, the general manager of the accounting and investment department at Mitsui Sumitomo Aioi Life Insurance Co. in Tokyo, which manages the equivalent of $25 billion, said yesterday. “I don’t think any of them are very keen to buy linkers.”

Foreigner Bets

The skepticism about an immediate threat of inflation is limiting gains in longer-term conventional bond yields. Japan’s 30-year rate rose one basis point yesterday to 2.005 percent. That’s below the five-year average of 2.1 percent and just above the BOJ’s inflation target.

“The steepening in the swap curve would indicate perhaps that foreign investors are seeing more inflation risk than domestic investors,” RBS’s Gibbs said.

Japan’s 2018 inflation-linked debt tumbled to 76.342 yen in December 2008, three months before the nation’s core inflation rate began two years of decline. The price has recovered since then as the Ministry of Finance bought up the securities.

The principal on linkers rises if consumer princes gain. Japan’s existing securities offer no floor for a decline in their face value.

The ministry plans to sell 600 billion yen of 10-year inflation-linked bonds in the fiscal year beginning April 1 with a guarantee of principal, it said on Jan. 29 in its debt issuance plan for fiscal 2013. As 91 percent of Japan’s government bonds are owned locally, there will be demand for these securities from domestic money managers, said Martin Malone, a rate strategist in London at Mint Partners.

“If you want to really scientifically hedge a fixed-income portfolio for inflation risk, you should buy an inflation bond,” Malone, who lived in Japan for a decade, said on Jan. 29. The new linkers “should be a very attractive investment instrument for domestic Japanese investors because there’s no inflation hedge on their fixed-income portfolios.”

To contact the reporters on this story: Masaki Kondo in Singapore at; Monami Yui in Tokyo at; Yumi Ikeda in Tokyo at

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

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