Narrowing Yield Gap Signals Dimming Recovery Bets: Japan Credit

Narrowing Yield Gap Signals Dimming Recovery Bets
A security guard stands outside the Bank of Japan headquarters at night in Tokyo. Photographer: Tomohiro Ohsumi/Bloomberg

The bond market is signaling doubts about Japan’s recovery from a record earthquake even as the Bank of Japan lifts its assessment on the economy.

The central bank last week raised its monthly economic assessment for the first time since February, as policy makers saw signs of a rebound. Data yesterday showed exports dropped by more than economists estimated in May, as Prime Minister Naoto Kan struggles to assemble a second supplementary budget before fulfilling a pledge to step down.

The yield spread between 10-year government bonds and two-year notes is at 96.5 basis points, about two points from this year’s low as chances dimmed that growth-fueled inflation would sap the value of the longer-maturity securities. Ten-year rates, already the world’s lowest, have fallen more than 20 basis points since their post-quake high on April 11, as doubts about economic growth boosted demand for the safest assets.

“People look to be paring expectations for the economic outlook, as is shown by the move of bond yields,” said Takeshi Minami, chief economist in Tokyo at Norinchukin Research Institute Co., a unit of Japan’s biggest lender for farmers and fishermen. “Funds are moving to higher-yielding, longer-maturity bonds.”

Japan’s benchmark 10-year yield added half a basis point to 1.120 percent at the 11:05 a.m. morning close in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker, 1.5 basis points off of its lowest level this year. The two-year note yielded 0.16 percent yesterday and the gap between it and the longer security reached a 2011 low of 94 basis points on May 12.

The magnitude-9 temblor and subsequent tsunami on March 11 crippled a nuclear power plant and disrupted supply of components, prompting companies including Honda Motor Co. to forecast weaker earnings.

Falling Exports

Exports decreased 10.3 percent in May from a year earlier, the Finance Ministry said yesterday, while economists had projected an 8.4 percent decline. It was the second-biggest trade deficit since comparable data were made available in 1979. A separate report last week showed that machinery orders decreased in April for the first time in four months.

The International Monetary Fund cut its 2011 forecast for Japan on June 17, expecting the economy to shrink 0.7 percent, compared with its April projection of a 1.4 percent expansion. The median estimate of economists compiled by Bloomberg calls for a 0.4 percent contraction this year and 2.8 percent growth in 2012.

‘Too Little’

While economists and the BOJ expect reconstruction efforts will help boost Japan’s economy, Kan is struggling to muster support for a new spending bill. The second rebuilding package will be about 2 trillion yen, Katsuya Okada, secretary-general of Kan’s Democratic Party of Japan, said on June 15, which is half the size of the first plan. Kan survived a no-confidence motion this month and said he intends to stay on until a second plan is passed.

Kan may stay “one more month or month and half,” DPJ lawmaker Hajime Ishii said on June 15. Fellow ruling party lawmaker Azuma Koshiishi said Kan “must pass the baton on to a new leader.”

The 2 trillion-yen package is “too little, too late,” said Masaru Hamasaki, who helps oversee the equivalent of $18 billion as chief strategist at Toyota Asset Management Co. in Tokyo. “The longer political turmoil lasts, the worse it will become” for Japan’s economy, he said.

BOJ Easing

Moody’s Investors Service put Japan’s debt rating on review for a downgrade in May and this month said the nation’s “revolving door” leadership was a credit negative factor. Kan is the fifth prime minister since September 2006.

Credit-default swaps protecting Japan’s debt from losses for five years gained to 93 basis points as of June 20 prices from a post-quake low of 77.3 basis points on April 25, CMA prices in New York showed. CMA is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The Bank of Japan kept its benchmark interest rate on June 14 at a range of between zero and 0.1 percent. The central bank also left unchanged its 10 trillion-yen fund that buys assets, including government bonds.

“It’s possible that the BOJ may add about 5 trillion yen to the asset-buying fund,” said Norinchukin’s Minami. Because the BOJ’s easing is expected to keep yields low, he recommends buying debt with a maturity of up to five years.

The yield spread between two-year U.S. notes and similar-maturity Japanese debt narrowed to 20 basis points on June 15, the least since Nov. 4, as concern the U.S. economy will lose momentum boosted demand for government securities.

U.S. reports this month showed that the jobless rate rose back above 9 percent, consumer confidence fell, the housing market weakened and manufacturing slowed. The country is Japan’s second-biggest export market after China by the value of products shipped last year, according to Japan’s Finance Ministry.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE