Japan’s Bonds Decline as Ozawa Concerns Damp Demand at Auction

Japanese bonds fell, pushing 10-year yields back over 1 percent, as demand for the securities waned at an auction today amid speculation a government led by Ichiro Ozawa would sell more debt to fund spending programs.

Longer-maturity bonds led declines as the lowest-accepted price at the 2.2 trillion yen ($26 billion) 10-year sale was less than traders forecast. Today’s auction was the last before a Sept. 14 party ballot pitting Ozawa against Prime Minister Naoto Kan. Bond futures slid the most in 11 weeks as stocks rallied after reports showing growth in Chinese manufacturing and the Australian economy.

“What’s behind this weak auction result is Ozawa’s candidacy and concern his administration would adopt an aggressive fiscal policy, resulting in an increase in the supply of bonds,” said Susumu Kato, Tokyo-based chief economist for Japan at Credit Agricole CIB and CLSA. “We have to take account of the possibility he’ll become prime minister.”

The yield on the benchmark 10-year bond climbed five basis points to 1.025 percent as of 3:41 p.m. at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The 1.1 percent security due June 2020 slid 0.450 yen to 100.667 yen.

Ten-year bond futures for September delivery dropped 0.48 to 142.51 at the afternoon close of the Tokyo Stock Exchange, the biggest drop for a benchmark contract since June 10.

Today’s auction of 10-year bonds attracted bids for 3.16 times the amount on offer, down from a so-called bid-to-cover ratio of 4.18 at the previous sale in August. The lowest-accepted price was 99.45, below the median forecast of 99.50 predicted in a Bloomberg News survey of 13 traders.

Leadership Contest

Kan this week rejected a closed-door effort to appease his party’s largest faction, forcing a contest with Ozawa for the Democratic Party of Japan leadership. Ozawa, a former party leader, pledges to increase a monthly childcare allowance from 13,000 yen, according to his manifesto released today. The winner of the ballot is ensured of being prime minister because the DPJ controls the lower house.

“Ozawa is seen to favor aggressive government spending, and his candidacy has reminded investors of possible worsening of the government’s finances,” Shinji Nomura, chief debt strategist in Tokyo at Nikko Cordial Securities Inc., wrote in a note to clients today. “This isn’t a temporary theme but a serious issue.”

China Manufacturing

Bonds extended losses after a Chinese government report showed manufacturing improved more than economists forecast in August. China was Japan’s biggest export market by the value of products shipped during the first half of 2010, according to the Ministry of Finance.

Australia’s economy grew at the fastest pace in three years, the Bureau of Statistics said in Sydney today. China is Australia largest trading partner.

“More and more people are coming to think China’s economy won’t decelerate as much as they’d previously feared,” said Masaru Hamasaki, chief strategist at Tokyo-based Toyota Asset Management Co., which oversees about $15 billion in assets. “Expectations are still there that demand in China will bolster the Japanese economy.”

The Nikkei 225 Stock Average gained 1.2 percent, reversing an earlier loss.

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