Pimco Says 7-8 Year, 20-Year JGBs Cheap on Distorted Yield Curve

Pacific Investment Management Co. is focusing on Japanese government debt maturing in 7 years to 8 years and 20 years that is relatively cheap, said Tomoya Masanao, head of portfolio management for Japan.

“The 10-year government bond yield is so low and is not justifiable from a fundamental perspective,” Masanao said in an interview in Tokyo on Sept. 24. “There is hardly any room for yields to fall any further” on three-to-six year notes.

Pimco, which runs the world’s biggest bond fund, is basing its strategy on what it calls the “distortion” of the yield curve caused by the Bank of Japan’s unprecedented bond-buying program, Masanao said. The central bank announced on April 4 that it would buy more than 7 trillion yen ($71 billion) of JGBs a month to achieve 2 percent inflation in two years.

Benchmark 10-year and 20-year yields dropped to four-month lows of 0.665 percent and 1.545 percent respectively, earlier this week. The extra yield investors demand to hold 2033 debt over 10-year securities fell to 0.88 percentage point on Sept. 25, the least since July 9. On the same day, the gap between six and eight year rates narrowed to a four-month low.

“The JGB market is moving to a world where yields are artificially suppressed by the BOJ’s large government bond purchases from one where yields were fundamentally low,” said Masanao. “Yields will probably correct upward at some point as the economy improves.”

The 10-year yield was little changed at 0.685 percent as of 9:11 a.m. in Tokyo, according to Japan Bond Trading Co., the nation’s biggest interdealer debt broker.

Abenomics Outlook

Investors will probably demand higher yields to hold JGBs after 6 to 12 months whether or not Abenomics succeeds, Masanao said, referring to Prime Minister Shinzo Abe’s stimulus program of monetary easing, fiscal stimulus and regulatory reform.

“If Abenomics fails, the economy may just return to where it was before -- a deflation equilibrium -- but investors may react differently and demand a higher risk premium in JGBs, as they will conclude that Japan will be unable to take any more measures to exit deflation while public debt increases further,” Masanao said.

Japan’s inflation accelerated to the fastest pace since 2008 in August on higher energy costs, a government report showed today. Consumer prices excluding fresh food increased 0.8 percent from a year earlier, the statistics bureau said. The median forecast of 30 economists surveyed by Bloomberg News was for a gain of 0.7 percent.

IMF Estimate

The International Monetary Fund estimates Japan’s debt will grow to 245 percent of gross domestic product this year. The nation will spend 22.2 trillion yen servicing debt in the fiscal year begun in April, accounting for more than half of total tax revenue and occupying about 24 percent of the government’s budget, Finance Ministry estimates showed in January.

“It’s not wise for long-term investors to aggressively buy JGBs at current levels,” Masanao said. “Yields are likely to stay capped at low levels in the near term, but we are probably close to a bottom of the range.”

Japan’s 10-year bond yields were as low as 0.315 percent and as high as 1 percent this year.

Investors may want to avoid yen debt when choosing corporate securities, according to Masanao.

“We don’t see yen-denominated corporate bonds attractive to overweight because the credit spreads are extremely tight,” he said. “The dollar-denominated corporate bonds issued by Japanese megabanks are attractive even compared to global peers, given their high credit quality and the domestic economy’s growth prospects.”

Japanese corporate bonds have returned 0.2 percent this month, while company debt worldwide has gained 0.7 percent, Bank of America Merrill Lynch data show.

Pimco, which is based in Newport Beach, California, and is a unit of the Munich-based insurer Allianz SE. (ALV)

To contact the reporters on this story: Mariko Ishikawa in Tokyo at mishikawa9@bloomberg.net; Shigeki Nozawa in Tokyo at snozawa1@bloomberg.net

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

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