Longest Rally in Nine Years for JGBs on Deflation: Japan Credit

Extra Scrutiny of Bank of Japan Pledged by Noda’s Economy Chief
A pedestrian walks past the Bank of Japan headquarters in Tokyo. Reports last week showed consumer prices in August matched the steepest decline in 16 months and industrial output fell more than forecast, increasing prospects the Bank of Japan will expand stimulus as early as this week. Photographer: Tomohiro Ohsumi/Bloomberg

Japanese government bonds are set to extend the longest quarterly rally in nine years as faltering demand cements deflation in the world’s third-largest economy.

JGBs handed investors a 0.5 percent return from June 30 to the end of September, marking a sixth quarter of gains that matched a similar stretch in 2003, according to Bank of America Merrill Lynch data. They are the longest winning streaks since a 13-quarter run from October 1990, the year Japan’s asset bubble collapsed. U.S. Treasuries had a three-month return of 0.58 percent, the second-straight advance, the data show.

Reports last week showed consumer prices in August matched the steepest decline in 16 months and industrial output fell more than forecast, increasing prospects the Bank of Japan will expand stimulus as early as this week. The benchmark 10-year yield, the third-lowest in the world, will stay below 1 percent for another year, according to a Bloomberg News survey of banks and brokerages. Switzerland and Japan are the only two major economies where consumer prices are falling, prompting the BOJ to unveil a 1 percent inflation goal in February.

“Japan’s yields are unlikely to rise because it’s clear that the central bank will have to keep its accommodative stance,” said Takuma Sugawara, a senior JGB strategist at Societe Generale SA, one of the 25 primary dealers obliged to bid at sovereign debt sales. “Deflation is continuing, and there’s a long way to go before the BOJ’s price goal is met.”

Japan Yields

Japan’s bonds gained each day last week. The yields on the benchmark 10-year notes fell to 0.76 percent today, the least since Aug. 7. The rate touched 0.72 percent on July 23, the lowest level since records were set in 2003, and way off from the all-time high of 8.7 percent in 1990. Only Switzerland and Hong Kong have lower interest rates.

The 10-year yields will finish this year at 0.87 percent, according to the Bloomberg survey of financial firms, with the most recent forecasts given the heaviest weightings. They expect the rate will be at 1.05 percent by the third quarter of 2013, which would mark the first quarter with yields closing over 1 percent since the three months ended September 2011.

Elsewhere in Japan’s credit markets, Credit Saison Co., a Tokyo-based consumer lending company, registered to sell as much as 300 billion yen ($3.9 billion) of bonds, according to a filing on Sept. 28 with the Ministry of Finance. Another filing showed Corporacion Andina de Fomento -- a joint development venture of the governments of Bolivia, Colombia, Ecuador, Peru, and Venezuela -- registered to offer as much as 100 billion yen of Samurai notes.

Bond Returns

Shelf registration allows for bond sales without obligating company or country to borrow. Samurai notes are yen-denominated debt issued by overseas borrowers in Japan.

Domestic corporate bonds handed investors a 0.15 percent return last quarter, compared with the 1.41 percent gain for Samurai debt, according to Bank of America Merrill Lynch index data. Company notes worldwide returned 3.9 percent, the data show.

Japan’s economy has slipped in and out of recession since its asset bubble burst in 1990, growing an average 0.9 percent a year in the past two decades. The Nikkei 225 Stock Average topped out at 38,957.44 in 1989 and tumbled as much as about 50 percent the next year. The gauge was at 8,808.17 today.

Rising Yen

Compounding the nation’s woes is the strength of the yen, which rose 7.5 percent over the past six months, the most among the 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. A higher yen reduces earnings at exporters when repatriated and makes their goods pricier overseas, a factor Finance Minister Jun Azumi described last week a big “demerit” for the economy.

The currency reached as strong as 77.44 per dollar on Sept. 28, a two-week high and within 3 percent of the post-World War II record of 75.35 on Oct. 31. It was at 77.88 at 2:19 p.m. in Tokyo.

Prime Minister Yoshihiko Noda named Koriki Jojima today to replace Azumi as finance minister as part of a cabinet reshuffle. Jojima will lead the nation’s currency policy.

Japan’s consumer prices excluding fresh food slid 0.3 percent in August from a year earlier, the statistics bureau said on Sept. 28. The so-called core inflation rate has never been above 1 percent for more than a year since 1993. The comparative gauge in Switzerland dropped 1.1 percent in August.

Separate data the same day showed Japan’s industrial production fell 1.3 percent from July, more than double the median economist estimate.

BOJ Policy

The BOJ on Sept. 19 increased by 10 trillion yen to 55 trillion yen its asset-purchase program, which has served as the central bank’s main policy tool since it cut benchmark interest rates to near zero. Governor Masaaki Shirakawa and his board gather twice this month on Oct. 4-5 and Oct. 30. Policy makers will update forecasts for prices and the economy for the 2012 and 2013 fiscal years on the latter date.

Waning consumer demand among the world’s most rapidly aging society is helping to prolong deflation. More than a quarter of Japan’s population will be over 65 years old in 2014, according to U.S. Census Bureau estimates compiled by Bloomberg.

Declines in consumer prices enhance the value of the fixed payments on debt, prompting domestic banks to channel customer deposits into government bonds rather than lending.

Customer deposits held by Japan’s banks exceeded loans by a record 171.7 trillion yen in August, data from the BOJ show. Domestic lenders held 167.4 trillion yen in government bonds at the end of July, separate central bank figures indicate. The record was 171 trillion yen in March, which is almost equivalent to Italy’s annual economic output in dollar terms.

Bond Auction

“When the BOJ floods the banking system with yen, those funds find their way into JGBs,” said Junya Tanase, the chief currency strategist at JPMorgan Chase & Co. in Tokyo. “And then you get lower yields as a result.”

The Ministry of Finance will sell 2.3 trillion yen of 10-year notes on Oct. 4. The last sale of the securities on Sept. 4 drew bids valued at 2.84 times the amount on offer, compared with the average of 3.09 for the prior 10 auctions.

“Japanese financial institutions still have ample cash,” said Tetsuya Miura, chief market analyst at Mizuho Securities Co., a unit of Japan’s third-biggest bank by value. “I don’t think the auction results will come in bad.”

The BOJ’s Tankan report today showed the nation’s biggest manufacturers grew more pessimistic last quarter.

Tankan Worsens

The quarterly index of business confidence deteriorated to minus 3 from minus 1, the fourth-straight quarter that pessimists outnumbered optimists, the central bank said today in Tokyo. That marked the longest string of negative readings since Japan emerged from the global recession in mid-2010.

The data add to evidence that Japan’s economy is shrinking as exports fall and political tensions with China mount. JPMorgan, Barclays Plc and BNP Paribas SA are among banks expecting a contraction in the third quarter after growth slowed to a 0.7 percent annual pace in the previous three months.

“It’s inevitable that Japan will go into an economic lull, teetering on the edge of a technical recession,” said Kenji Sakaguchi, who oversees 6.5 trillion yen of bonds as chief investment officer at Prudential Investment Management Japan Co., a unit of the second-largest U.S. life insurer. “You can’t be bullish on the outlook, so it’s hard to imagine an advance in yields,” said Sakaguchi, who sees the 10-year yield falling as low as 0.7 percent over the next six months.

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