Spread Dropping to Nine-Month Low Signals More Easing by BOJ: Japan Credit

Japan’s two-year bonds yielded the least relative to overnight lending rates between banks in nine months on speculation the Bank of Japan will add to monetary easing to counter the yen’s advance against the dollar.

The spread fell to 4.9 basis points yesterday, the least since Nov. 4. The two-year overnight-index swap rate, an indication of what traders expect the Bank of Japan’s key interest rate will average during the period, sank to 0.05 percent, the least since Oct. 5. The comparable U.S. rate slid to 0.07 percent on Aug. 11, a level not seen since Dec. 2001.

Traders are increasing bets that the BOJ will keep up with its U.S. counterpart in monetary easing after the Federal Reserve pledged this month to keep interest rates at a record low through the middle of 2013. Fed Chairman Ben S. Bernanke is scheduled to speak this week amid speculation the central bank will introduce a third round of Treasury bond purchases to lower borrowing costs and stimulate the economy.

“The market has started pricing in further easing from the Bank of Japan,” said Makoto Noji, a senior debt and foreign- exchange strategist at SMBC Nikko Securities Inc. in Tokyo, one of the 25 primary dealers obliged to bid at government debt sales. “There may be an unspoken understanding between the Fed and BOJ,” for example, if the Fed eases policy, the BOJ will follow, he said.

‘Feeling of Powerlessness’

The yen climbed to a post-World War II record of 75.95 per dollar on Aug. 19, threatening to derail Japan’s export-led recovery. BOJ Deputy Governor Hirohide Yamaguchi said on Aug. 21 that he is worried about the yen’s appreciation. Finance Minister Yoshihiko Noda said yesterday he will take “bold actions if necessary.” The yen traded at 76.79 per dollar today in Tokyo.

While Japan sold the currency three times in the past 12 months, the yen surpassed its previous highs a few weeks after each intervention. When Japan intervened on Aug. 4 for a third time, the BOJ expanded its asset-purchase fund, doubling its investment in domestic government bonds to 4 trillion yen ($52 billion), and kept its benchmark interest rate near zero.

“There is a feeling of powerlessness and doubt that nothing will take effect” to stop the yen’s advance, said Tetsuya Miura, chief market analyst at Mizuho Securities Co., another primary dealer. “I think the BOJ will introduce another easing step at the next meeting” on Sept. 7.

U.S. Outlook

A stronger yen decreases the value of overseas earnings for the nation’s exporters when repatriated. It also makes Japanese- made products costlier overseas.

Yields on U.S. Treasuries tumbled to record lows this month, reducing the allure of dollar-denominated assets. The Fed said Aug. 9 that a U.S. recovery was “considerably slower” than anticipated and it’s prepared to use a range of policy tools to boost the economy.

U.S. gross domestic product grew at a 1.3 percent pace in the second quarter, missing the economist estimate for a 1.8 percent increase, a Commerce Department report showed last month. Citigroup Inc. and JPMorgan Chase & Co. cut their U.S. growth forecasts last week.

Bernanke is scheduled to speak on Aug. 26 at a conference in Jackson Hole, Wyoming, where Bernanke foreshadowed the second round of so-called quantitative easing last year. The central bank completed the $600 billion bond-purchase program in June.

The 10-year Treasury yield sank to a record 1.9735 percent Aug. 18. The extra yield it offers over similar-maturity Japanese debt fell to 1.06 percentage points on Aug. 10, the least since January 2009.

Keep Dancing

Barclays Plc said 10-year yields indicate traders have priced in $500 billion to $600 billion of Treasury purchases by the Fed. Citigroup Inc. said current rates can only be justified by more central bank bond buying or assuming the economy will shrink by 2 percent.

Japan’s 10-year bonds yielded 1.005 percent today in Tokyo after reaching 0.97 percent on Aug. 19, the lowest since Nov. 9.

“A dance party never ends until the music stops,” said Mizuho’s Miura. “As long as concerns about an economic recovery are playing like tunes here and there, we should keep dancing in the bond-buying party.”

To contact the reporters on this story: Masaki Kondo in Singapore at mkondo3@bloomberg.net; Monami Yui in Tokyo at myui1@bloomberg.net

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

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