Treasuries Bulls in Japan Signal Rally as U.S. Bears Scatter

The most aggressive foreign buyers of U.S. government debt see little reason to turn bearish after the biggest gains in longer-term Treasuries for two decades.

Japanese investors from Sumitomo Mitsui Trust Asset Management Co. to Mitsubishi UFJ Asset Management Co. say the lack of wage growth to spur U.S. inflation means owning the bonds still makes sense. Japan plowed $86 billion into Treasuries in the past 12 months, the most among the world’s 10 biggest economies, data compiled by Bloomberg show.

Demand from the Asian nation lends credibility to the view Treasuries can rally further because the Japanese have contended with falling consumer prices and growth that’s lagged behind the world for more than 15 years. Sumitomo Mitsui and Mitsubishi UFJ Asset were among investors that piled into longer-term Treasuries at the end of 2013, when bearishness reached a crescendo as most forecasters predicted losses.

“There’s still a risk of disinflation in the American economy,” Hideaki Kuriki, a Tokyo-based bond trader at Sumitomo Mitsui Trust, which oversees $41.1 billion in assets, said in a telephone interview on May 15. “Inflation is low. Wages aren’t strong. Any increase in yields will be limited.”

Even as the Federal Reserve scales back its own bond buying, yields on 10-year Treasuries fell to a six-month low last week. Adjusted for living expenses, they still yielded more this year versus Japanese government debt than at any time since 1998, monthly data compiled by Bloomberg show.

Relative Value

Wall Street prognosticators started 2014 saying a selloff in Treasuries would lift yields to 3.44 percent by year-end. They cited a strengthening economy and tapering in Fed stimulus that had inundated the financial system with more than $3 trillion in cheap money since 2008.

Uneven economic growth, unrest in Ukraine and speculation the European Central Bank will start its own quantitative easing caused Treasuries to surge instead this year, reducing 10-year yields by more than a half-percentage point to as low as 2.47 percent on May 15. They ended at 2.52 percent last week and were at 2.51 percent as of 12:05 p.m. in New York.

Treasuries due in 10 years or more have returned 11.4 percent this year, trouncing stocks and junk bonds. The advance was the biggest on a year-to-date basis since 1995, data compiled by Bank of America Merrill Lynch show.

For Mizuho Asset Management Co., the gains are a vindication of its embrace of 30-year bonds. They returned 13.2 percent this year, also the most since 1995, and pushed yields to an 11-month low of 3.3 percent last week.

‘Headed South’

“Yields are headed south,” said Yusuke Ito, a Tokyo-based senior fund manager at Mizuho Asset, which oversees $39 billion, by telephone on May 15.

The firm’s purchases helped bolster Japanese holdings of U.S. debt to a record $1.21 trillion in February, Treasury data compiled by Bloomberg show. On a trailing 12-month basis, Japan has been the biggest net buyer of Treasuries each month since December, when it overtook China as the biggest purchaser.

The increase in Japan’s investment during the period ended March, the most recent available data, contrasts with a $29 billion decline from the other major economies combined.

Wall Street economists, who have scaled back their forecasts, still foresee 10-year yields increasing to 3.25 percent by year-end as growth accelerates this year and next, according to the median of 72 estimates compiled by Bloomberg.

Too Low

“Yields are way too low,” Jennifer Vail, Minneapolis-based head of fixed-income research at U.S. Bank Wealth Management, which oversees $112 billion, said on May 15. “The market is mispricing. They were unattractive at 3 percent and they’re unattractive at 2.5 percent.”

Michael Novogratz, principal at Fortress Investment Group LLC, the New York-based hedge fund manager which oversees $62.5 billion, said 30-year bond yields are so low it doesn’t make sense to be bullish and there’s a chance to bet against them.

“Having a sizable short makes sense,” Novogratz said at the SkyBridge Alternatives Conference in Las Vegas on May 15.

The lack of inflationary pressure is one of the biggest reasons Japanese investors still prefer Treasuries. The Fed’s preferred gauge of inflation has fallen short of the bank’s 2 percent target for 23 months. Since reaching a high of 2.9 percent in the year ended September 2011, the measure has slowed to 1.1 percent as of March.

Wages are to blame, said Hideo Shimomura, the chief fund investor at Mitsubishi UFJ Asset in Tokyo.

Real Yields

Even though the jobless rate fell to five-year low of 6.3 percent in April, average hourly earnings failed to increase from March. From a year earlier, wages rose 1.9 percent, matching the smallest increase in 18 months.

“Everybody is worried about wage growth,” Shimomura said in an e-mail on May 12. “It’s a disinflationary situation.” Yields on 10-year notes may decrease to 2 percent in the second half of the year, he said.

With few catalysts to push up U.S. consumer prices, Treasuries provide even bigger returns relative to Japanese bonds. Measures to combat Japan’s malaise since its asset bubble burst in the early 1990s are starting to spur inflation after prices fell an average 0.2 percent over the past 15 years.

Ten-year Japanese bonds yield a full percentage point less than inflation, meaning local investors lose purchasing power holding the debt. The real-yield advantage for 10-year Treasuries reached 2.44 percentage points over Japanese bonds in February, the most on a monthly basis in 15 years.

Kazuyuki Takigawa, who manages $6 billion of bonds as the chief fund investor for foreign fixed income at Resona Bank Ltd. in Tokyo, remains bullish after buying 10- and 30-year Treasuries at the start of the year.

“We have a long position and we’re keeping it,” he said by telephone on May 15.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net

To contact the editors responsible for this story: Garfield Reynolds at greynolds1@bloomberg.net Michael Tsang, Dave Liedtka

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