Japan's Bond Futures Approach Two-Month Low Before Tomorrow's 20-Year Sale

Japanese bond futures fell toward a two-month low on speculation primary dealers cut their debt holdings to prepare for a 1.1 trillion yen ($13.2 billion) sale of 20-year securities tomorrow.

Ten-year bonds dropped for the first time in three days before a U.S. report tomorrow forecast to show a gauge of consumer confidence in the world’s largest economy was near a three-year high, reducing the allure of government debt. Japanese inflation swaps surged last week as traders increased bets that deflation is being beaten.

“The market is likely to remain soft before the auction of 20-year debt,” said Makoto Yamashita, chief rate strategist in Tokyo at Deutsche Securities Inc., the brokerage unit of Deutsche Bank AG. “Investors aren’t inclined to buy with 10- year yields at around 1.3 percent.”

Ten-year futures for March delivery fell 0.05 to 138.97 at the 3 p.m. close of the Tokyo Stock Exchange. The contracts fell to 138.32 on Feb. 9, the lowest level since Dec. 15.

The yield on the benchmark 10-year bond climbed one basis point to 1.305 percent as of 3:29 p.m. at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The 1.2 percent security due December 2020 dropped 0.086 yen to 99.086 yen. The 20-year yield was unchanged at 2.045 percent.

Demand may wane at tomorrow’s auction as the extra yield offered by 20-year bonds over 10-year debt has narrowed to 73.8 basis points from this year’s high of 83 basis points last month.

‘Narrowing Spread’

“The narrowing spread between 10-year bonds and 20-year debt prompts some caution before the sale,” Akihiko Inoue, chief market analyst at Mizuho Investors Securities Co., wrote today in a note to clients.

Primary dealers, which are required to bid at government debt sales, often reduce holdings of bonds before an auction in case prices decline before they can pass on the new securities to investors. Deutsche Securities and Mizuho Investors are among the 24 primary dealers.

The Conference Board’s index of U.S. consumer confidence was 65 this month, according to a Bloomberg survey before tomorrow’s report. The reading was 65.6 in January, the highest level since March 2008. U.S. financial markets are shut today for a holiday.

“Confidence in the economic recovery is strong, especially in the U.S.,” said Shuntaro Take, deputy general manager for corporate investment at Tokio Marine & Nichido Life Insurance Co., which manages the equivalent of $40 billion in assets. “There are few catalysts that prompt investors to buy bonds.”

Middle East

Five-year inflation swaps, which allow investors to exchange fixed interest rates for returns equivalent to Japan’s consumer price index, jumped 81 percent on Feb. 18, the biggest gain since October 2008. The breakeven rate, a gauge of inflation expectations derived from the spread between yields on nominal and index-linked five-year bonds, was at 0.4 percent that day, compared with a low of negative 1.5 percent in May.

Prime Minister Naoto Kan said today the economy is showing signs of escaping from more than a decade of deflation.

The decline in bonds was tempered on speculation widening unrest in the Middle East will spur demand for safer assets.

Arab governments are cracking down on pro-democracy activists as uprisings that toppled leaders in Tunisia and Egypt spread to Libya, Algeria, Yemen and Bahrain. Libya’s Saif al- Islam Qaddafi called on protesters to engage in dialogue or face a civil war that risks “hundreds of thousands of dead,” as a widening revolt posed the most serious challenge to his father’s 41 years of rule.

“With unrest unfolding in oil-producing countries, there is a risk that oil prices will rise,” Tokio Marine’s Take said. “It should be a positive for Japanese bonds, as I see a chance that the world’s economy will cool.”

To contact the reporters on this story: Masaki Kondo in Singapore at mkondo3@bloomberg.net; Nobuyuki Akama in Tokyo at akam@bloomberg.net.

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net.

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