Japan's Yields May Surge to 1.75% Amid `Bubble Signs,' Nikko Cordial Says

Japan’s 10-year bond yields, mired in the past week at the lowest levels in seven years, may surge to 1.75 percent by year-end as the nation’s economic recovery proves resilient, according to Nikko Cordial Securities Inc.

Benchmark 10-year yields fell 31 basis points in the quarter ended in June, the most since the last quarter of 2008, while sentiment among Japan’s largest manufacturers advanced to a two-year high. A basis point is 0.01 percentage point.

“I’m seeing bubble signs increasingly,” Shinji Nomura, chief debt strategist in Tokyo at Nikko Cordial, a unit of Japan’s third-largest banking group said yesterday. “The economy continues to recover gradually, but yields have dropped as if taking into account a new recession. That’s widened a gap between yields and the economic outlook.”

The Bank of Japan’s quarterly Tankan index, released yesterday, gained 15 points to plus 1 in the second quarter. That meant optimists outnumbered pessimists for the first time in two years.

“Judging from the Tankan’s results, I see no need for the BOJ to move toward additional easing,” Nomura said.

Following calls to act from the government the Bank of Japan in December unveiled a credit program that it doubled to 20 trillion yen ($228 billion) in March. Last month, Governor Masaaki Shirakawa and his policy board introduced a 3 trillion yen program aimed at encouraging lending to businesses.

The central bank has held its benchmark interest rate at 0.1 percent since December 2008.

Ten-year yields touched 1.055 percent yesterday, the lowest since August 2003. Japan’s government bonds handed investors a return of 2.2 percent between January and June, the best first half since 2001, according to an index compiled by Merrill Lynch & Co.

‘Going Wrong’

Yields are lower now than in the wake of Lehman Brothers Holdings Inc.’s collapse, though Japan’s economy is in a better state now than it was then, Nomura said. The Nikkei 225 Stock Average, which dipped below 7,000 in October 2008, closed at 9,191.60 yesterday.

“As we enter a new quarter, I’m sure investors are mulling over whether they can keep buying at current yield levels,” Nomura said. “They may be getting a sense that something is going wrong.”

Ten-year yields slipped to a record 0.43 percent on June 11, 2003, as investors kept buying government debt even after the economy bottomed out, causing an asset bubble, Nomura said. Yields surged to 1.4 percent on July 4, 2003, as bond prices tumbled.

“The situation is getting similar to that 2003 bubble,” he said.

Risk Premiums

Ten-year rates may rise to 1.75 percent by year-end, the highest level since June 2008, Nomura said. Should his forecast prove accurate, investors who buy the securities today will incur a 5 percent loss, Bloomberg data show.

Bond yields may also surge as optimism about the government’s fiscal strategy fades following this month’s midterm elections, Nomura said. Prime Minister Naoto Kan, who took over when Yukio Hatoyama resigned after nine months on the job, announced a plan on June 22 to balance Japan’s books within 10 years, restrict debt sales and overhaul the tax system.

“Kan’s administration may be short-lived,” he said. “If that happens, investors may think nothing has changed.”

Japan’s public debt, the world’s largest, is nearing 200 percent of gross domestic product, according to the Organization for Economic Cooperation and Development.

To contact the reporters on this story: Yoshiaki Nohara in Tokyo at ynohara1@bloomberg.net; Yumi Ikeda in Tokyo at Ikeda4@bloomberg.net

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