Bond Risk at Month High on Specter of Abe Spending: Japan Credit

Shinzo Abe
Shinzo Abe, Japan's former prime minister and president of the Liberal Democratic Party. Photographer: Tomohiro Ohsumi/Bloomberg

Japan’s bond market is signaling concern that a government run by Shinzo Abe will ramp up spending to revive growth, adding to a debt burden already twice the size of the nation’s economy.

The cost to protect Japanese government bonds against nonpayment for five years rose every day last week, reaching 76 basis points, the highest level since Oct. 30, according to CMA prices compiled by Bloomberg. Contracts on U.S. Treasuries were at 37.5 basis points. The extra yield that investors demand to hold 20-year JGBs instead of 10-year notes is hovering near a 13-year high, showing they are pricing in more long-term risk.

Abe’s Liberal Democratic Party, leading the ruling Democratic Party of Japan in opinion polls before the Dec. 16 elections, has called for a “large scale” extra budget to support growth. Data yesterday confirmed the world’s third-largest economy is in a technical recession, which could upend a plan to double Japan’s sales tax by 2015.

“If Abe pursues pork-barrel type spending and therefore has to increase bond issuance, a collapse of the JGB market wouldn’t be a surprise,” said Akihiko Inoue, chief strategist at Mizuho Investors Securities Co. in Tokyo, one of the 25 primary dealers obliged to bid at government debt sales. “We’re walking toward the day when bond yields will surge.”

The spread between yields on Japan’s 10- and 20-year government bonds touched 98.7 basis points on Dec. 5, the widest since March 1999. It has averaged at 74 basis points over the past five years and was at 96 today.

Policy Platform

The LDP wants large-scale fiscal outlays to support the economy and is calling for aggressive monetary easing by the Bank of Japan to reach 2 percent inflation, according to pledges on its website. Abe, the leader of the LDP and a former prime minister, has also said that economic conditions next year will determine whether the sales tax increase championed by sitting Prime Minister Yoshihiko Noda will go ahead.

The LDP is favored to take a majority in the lower house of parliament, the Nikkei newspaper reported on Dec. 6, citing its nationwide opinion polls. Noda’s DPJ may lose more than half of its seats, the newspaper reported.

Japan’s gross domestic product shrank an annualized 3.5 percent in the three months through September, the Cabinet Office’s second estimate showed in Tokyo yesterday, matching a preliminary reading. The government revised the previous quarter to a 0.1 percent contraction, meeting the textbook definition of a recession.

Yokohama City

Elsewhere in Japan’s credit markets, Yokohama City hired Barclays Plc, Daiwa Securities Group Inc., and Nomura Holdings Inc. to sell 20 billion yen in 10-year notes, Nomura said in an e-mailed statement yesterday.

Kurosaki Harima Corp., a maker of bricks used by steel and glassmakers, registered to sell up to 20 billion yen of bonds, according to a filing yesterday with the Ministry of Finance.

Japan’s corporate notes returned 1.5 percent this year, compared with a 2.3 percent gain on sovereign debt, according to Bank of America Merrill Lynch data. Company bonds worldwide returned 10.7 percent, the data show.

Abe’s monetary stimulus calls have helped weaken the yen by 5 percent in the past month, the worst performance among the 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. Japan’s Nikkei 225 Stock Average of shares has climbed about 10 percent since Nov. 13.

Yen Weakness

The Japanese currency was little changed at 82.40 per dollar at 10:31 a.m. in Tokyo, after rallying 0.2 percent to 82.36 yesterday. It touched 82.84 on Nov. 22, the weakest since April 4, and last year reached a postwar high of 75.35.

Japan’s benchmark bonds aren’t signaling any immediate concern about new spending or debt issuance following the election. The nation’s 10-year note yield slid half a basis point, or 0.005 percentage point, to 0.69 percent today. It reached a nine-year low of 0.685 percent last week. The all-time low is 0.43 percent reached in June 2003.

The BOJ refrained on Nov. 20 from expanding its 66 trillion-yen ($801 billion) asset-purchase fund, its main policy tool since cutting its overnight-rate target to between zero and 0.1 percent in October 2010. Policy makers will meet next on Dec. 19-20.

“Political pressure for the BOJ to conduct aggressive easing is inevitable,” said Makoto Yamashita, chief rates strategist in Tokyo at Deutsche Securities Inc. “The yield curve is flattening from the short-end through 10-year bonds as we aren’t in an environment where yields can rise.”

Japan is estimated to have public debt this year that’s equivalent to 237 percent of its annual GDP, according to the International Monetary Fund. That’s the highest debt-to-GDP ratio globally and compares with 107 percent for the U.S.

Outstanding Debt

Japan’s outstanding borrowings increased 0.7 percent to 983.3 trillion yen in the three months ended Sept. 30 from the previous quarter, 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.

Five-year credit-default swaps that insure Japan’s sovereign debt dropped 1 1/2 basis points to 74.5 basis points yesterday, according to CMA prices. That compared with 67.4 basis points touched on Nov. 30, the least since September 13 according to data from CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

Lower swap premiums indicate improving perceptions of creditworthiness, while higher contracts signal the opposite.

“Depending on how the election results pan out, it could put upward pressure on long-term interest rates,” said Tomo Kinoshita, chief economist at Nomura Holdings Inc. in Tokyo. The supplementary budget is “basically a good idea but I also think given the fiscal condition in Japan, it’s very important to think about financial sustainability.”

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