Prime Minister Shinzo Abe’s pledge to halt falling prices has caused bond investors’ expectations for inflation to surpass Germany’s by the most on record, after 14 years in which Japan’s living costs have lagged behind.
The five-year break-even rate in Japan, the difference between yields on inflation-linked bonds and conventional notes, rose to 1.54 percentage points this month and exceeded Germany’s by as much as 33 basis points, the most in data compiled by Bloomberg going back to 2009. This year, Japan’s rate has climbed at the fastest pace globally after that of the U.K.
Japan’s so-called linkers are set to post the biggest quarterly return in almost two years. The securities gained even as actual consumer prices, which haven’t risen faster than Germany’s since 1999, are forecast to have fallen 0.7 percent in February, according to economists surveyed by Bloomberg News. Investor sentiment turned around as Abe called for limitless cash provision to generate 2 percent annual price gains.
“The market is encouraged by the direction of where things are going in terms of seriousness to overcome deflation,” said Anton Heese, the global head of inflation research in London at Morgan Stanley. “The market is not pricing in the possibility that the target will be achieved, but investors are starting to price in more sizable possibility of that happening.”
Bank of Japan (8301) Governor Haruhiko Kuroda said in parliament today the BOJ will consider buying more government bonds with longer maturities and scrapping a self-imposed rule limiting the scale of asset buying to defeat deflation. He said at his inaugural press conference on March 21 that the central bank has to achieve its 2 percent inflation target through measures including lowering the entire yield curve through “decisive monetary easing.”
Germany’s consumer prices have risen at an annual average of 1.6 percent since 1999, compared with a 0.3 percent decline in Japan. The euro region’s biggest economy grew by 36 percent on a nominal, local-currency basis during the period, while Japan’s gross domestic product shrank 7.1 percent. Chancellor Angela Merkel has been in Germany’s top office since 2005, while Abe, who took power in December, is the nation’s seventh premier in six years.
The Asian nation’s linkers have returned 2.78 percent this year, poised to complete the biggest quarterly gain since the second quarter in 2011, according to a Bank of America Merrill Lynch index. Germany’s inflation-linked securities have lost 0.32 percent.
“Japan’s disinflation is deep-rooted,” said Teruyoshi Sotome, a Tokyo-based senior bond strategist at Mizuho Securities Co. “It’ll be very hard for the BOJ just to keep these expectations that markets have already priced in.”
Elsewhere in Japan’s credit markets, National Australia Bank Ltd. registered to sell 500 billion yen ($5.3 billion) of Samurai bonds, according to a filing yesterday with the Ministry of Finance. The registration takes effect April 2 and is valid for two years.
Samurai notes, which are yen-denominated securities offered in Japan by overseas borrowers, have handed investors 0.24 percent this month, according to Bank of America Merrill Lynch index data. Japanese corporate bonds have returned 0.31 percent, while company debt worldwide has gained 0.26 percent.
Five-year credit-default swaps that insure Japan’s sovereign debt rose to 71.7 basis points yesterday, the highest since Feb. 27, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. An increase in the contracts signals worsening perceptions of creditworthiness.
Longer-maturity debt led gains in Japanese government bonds in the past two sessions, indicating inflation is of little concern to domestic investors.
Twenty-year bond yields dropped to as low as 1.41 percent today, a level unseen since July 2003, while 30-year yields reached 1.545 percent, the lowest since August 2010. The benchmark 10-year rate touched 0.525 percent, the least since June 2003, when it reached a record 0.43 percent.
The yen has weakened more than 17 percent against the dollar in the past six months, the biggest loser among major currencies, as speculation that the BOJ will carry out cash infusions mounted. It touched 96.71 per dollar on March 12, the weakest since August 2009, and traded at 94.27 as of 11:58 a.m. in Tokyo. Currency depreciation typically helps boost exporters’ competitiveness while making imports more expensive.
Prices for imported goods climbed 13.2 percent in February from a year earlier following an 11 percent jump in January. They’re the first back-to-back, double-digit gains since August 2011. The world’s third-largest economy will probably grow by at least 2.2 percent every quarter through March 2014, according to economist estimates compiled by Bloomberg.
Japan’s break-even rate has advanced 55 basis points this year, the biggest increase after the U.K. among countries tracked by Bloomberg. A basis point is 0.01 percentage point. The Asian country’s Ministry of Finance, which suspended sales of linkers in August 2008, is planning to resume issuance in the year starting April 1, with a guarantee of principal in case the inflation rate declines.
Japan will raise the nation’s 5 percent sales tax to 8 percent in 2014 and further to 10 percent in 2015. BOJ policy makers forecast consumer prices less fresh food will rise 2.9 percent in the year starting April 2014, while they estimate a 0.9 percent gain in the so-called core-inflation rate excluding the impact of the planned tax increase.
Jasper Falk, the head of global inflation trading in London at JPMorgan Chase & Co., cited tight supply, a weaker yen and the planned guarantee on new Japanese linkers among the reasons for the higher inflation expectations.
“All these factors and the changing macro story are positive for the market, and hence the rally,” said Falk. “The government is really keen on changing what has become a cultural mindset for the last 20 years in Japan that prices don’t go up.”
Masaaki Shirakawa said at his last media briefing as BOJ governor on March 19 that there’s a “negative bubble,” in which people are excessively pessimistic in Japan. The country was slow in adjusting its economic and fiscal structure to a rapidly aging society and globalization, causing economic stagnation, he told reporters.
Prime Minister Abe has counted “bold” monetary policy as one of the three pillars of his economic measures, known as Abenomics. The other two are “flexible” fiscal policy and growth strategies.
“Consumers are concerned about whether they can repay their mortgage or receive their pension, and there has been no policy package that addresses these worries about future,” said Tadashi Matsukawa, who helps oversee $1.4 billion in assets including Japanese linkers as head of fixed income investment at PineBridge Investments Japan Co. in Tokyo. “Abenomics was born amid skepticism, and it’s just starting to climb the wall of doubt.”
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