Noda Credibility Cliff Widens JGB Gap to 1999 High: Japan Credit

Japanese Prime Minister Yoshihiko Noda
Yoshihiko Noda, Japan's prime minister. Photographer: Kiyoshi Ota/Bloomberg

The bond market is signaling concern that Japanese lawmakers struggling to pass legislation to fund the budget will founder in their efforts to cut the world’s largest debt.

The extra yield that investors demand to hold 20-year government bonds instead of 10-year securities stands at 92 basis points, the most since July 1999, according to data compiled by Bloomberg. Longer bonds tend to be more sensitive to the market’s fiscal outlook. The equivalent German gap widened less than two basis points this month to 76.

Japan’s opposition is blocking a bill allowing the government to borrow 38.3 trillion yen ($478 billion) for this year’s deficit as they press Prime Minister Yoshihiko Noda to call elections. While Standard & Poor’s said this month that political disputes may thwart attempts to reduce public debt, credit assessors have stopped short of threatening to downgrade Japan if the budget deal fails, as Moody’s Investors Service has for the U.S. government.

“Yields on super-long term bonds probably reflect concern that the deficit-financing bill won’t pass,” said Naomi Muguruma, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities Co., one of the 25 primary dealers obliged to bid at government debt sales. “As things stand now, Japan is facing a credibility cliff, unlike the U.S.’s fiscal cliff.”

Fading Popularity

Yields on 10-year notes rose half a basis point to 0.775 percent in Tokyo today, the lowest in the world after Switzerland and Hong Kong. They reached a nine-year low of 0.72 percent in July. The 20-year rate was unchanged at 1.7 percent, after climbing 2 1/2 basis points on Oct. 23, the fastest advance in a month on a closing basis, data compiled by Bloomberg show.

The so-called fiscal cliff in the U.S. is the spending cuts and tax increases that will kick in automatically at the end of the year unless Congress acts. In Japan, Noda’s popularity sank to a new low after he failed to persuade the opposition to back him on the budget-funding bill. Public support for the prime minister fell 5 percentage points to 18 percent, according to an Asahi newspaper poll published Oct. 22.

The delay of the bill’s passage risks a stoppage of government bond auctions. The legislation needs to be approved by November for the Ministry of Finance to hold debt sales as planned, according to records of the ministry’s Sept. 14 meeting with domestic institutional investors released on its website.

A sale of 2.7 trillion yen of two-year notes today saw the highest demand in seven years. Investors bid for 14.94 times the amount of securities on offer, the highest so-called bid-to-cover ratio since June 2005.

Insurer Investments

Elsewhere in Japan’s credit markets, Asahi Mutual Life Insurance Co. said it plans to boost holdings of Japanese bonds while reducing overseas notes. The insurer will add 180 billion yen in local debt, with the main focus on government securities, during the six months through March 31, according to Takahiro Ono, general manager of the asset allocation and planning unit at Asahi Mutual.

Japan Housing Finance Agency sold 145.4 billion yen of 1.12 percent residential mortgage-backed securities, Mitsubishi UFJ Morgan Stanley Securities said in a statement yesterday.

Japanese corporate bonds have handed investors a 1.4 percent return this year, compared with a 1.72 percent gain for the nation’s sovereign debt, according to Bank of America Merrill Lynch index data. Company notes worldwide have returned 9.74 percent, according to the data.

‘Abnormal’ Situation

The yen extended declines today after the Nikkei newspaper reported that Japan’s central bank will consider increasing its asset-purchase program by 10 trillion yen at its next meeting. The currency reached 80.17 per dollar, the lowest level since June 25.

Leaders of the two largest opposition parties said last week they couldn’t cooperate on the passage of the deficit-financing bill unless Noda promises a specific election date. Noda reached a deal with them in August to double the sales tax rate in return for promising to call elections “soon.” Noda isn’t legally obliged to dissolve the lower house of parliament and call an election until August 2013.

“It’s fairly abnormal that the legislation for deficit-financing bonds hasn’t passed yet,” said Hidenori Suezawa, Tokyo-based chief strategist at SMBC Nikko Securities Inc., another primary dealer. “If Japan has to halt bond auctions for a long period of time, it is likely to increase prospects for a downgrade. Overseas funds may find it a selling opportunity.”

Political Disputes

Suezawa predicts that the Ministry of Finance will suspend debt sales starting with the 10-year auction on Dec. 4 should the bill not pass, he wrote in a report dated Oct. 16.

S&P said it doesn’t expect the political deadlock over the bond legislation to pose immediate risks to Japan’s sovereign credit quality.

“However, the longer that political disputes delay implementation of additional government measures, the harder it will be to fix Japan’s fiscal and structural problems,” S&P said in an Oct. 15 report. “Government access to cheap funds in such circumstances is neither infinite nor indefinite.”

The rating company, which has an AA- grade on Japan with a negative outlook, said a week later that the nation runs the risk of a credit downgrade if its “debt trajectory were to remain on its current course.”

Gangster’s Wedding

Fitch Ratings, which lowered the nation’s credit grade by two levels to A+ on May 22 with a negative outlook, said Japan’s “convoluted politics” are inhibiting policy makers’ attempts to reduce deficits, according to a statement released last month.

In the latest blow to Noda, Keishu Tanaka stepped down as justice minister this week after apologizing for attending a gangster’s wedding and accepting donations from a foreign-run company.

Japan’s outstanding borrowings increased 1.7 percent to 976.2 trillion yen in the three months ended June 30, government figures show. The nation may need a record 24.6 trillion yen to service debt in the year starting April 2013, according to finance ministry projections.

The ratio of debt to gross domestic product will probably rise to 250 percent in 2017 from 237 percent this year, estimates by the International Monetary Fund show. The ratio is the highest globally and compares with Greece’s 171 percent in 2012.

Default Risk

The surge in public borrowing has yet to spur an increase in bond risk. Japan’s current account, the broadest measure of trade, has been in surplus on an annual basis since at least 1985. That’s helped the government finance deficits without relying on foreign capital, and in turn bolstered the yen’s status as a refuge asset.

The cost to insure the nation’s sovereign debt was 76.5 basis points yesterday, down from this year’s high of 154.1 basis points on Jan. 11, according to CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. A gain in credit-default swaps signals deteriorating perceptions of creditworthiness, while a decline suggests the opposite.

Even so, the widening gap between 10-year and super-long debt yields suggests investors are growing more concerned about future JGB losses. Among bears on Japan’s bond market is Hayman Capital Management LP, which thinks yields could surge toward 10 percent as the nation’s trade deficit deepens.

Money managers who invest $100 million in 20-year bonds would lose $15 million should their yields rise 1 percentage point, according to data compiled by Bloomberg on so-called duration. The same degree of a yield gain would cause a loss of $9.2 million in 10-year securities.

“I’m scared that one day the financial market will start fully pricing in political risks,” said Ayako Sera, a Tokyo-based market strategist at Sumitomo Mitsui Trust Bank Ltd., which manages the equivalent of $163 billion. “Yields will be much higher once that happens.”

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