Linkers Dropping Most Since Lehman Show Deflation Deepening: Japan Credit
Japan’s inflation-linked bonds are poised for a second monthly decline as the stronger yen exacerbates deflationary pressure on an economy still reeling from a record earthquake and a nuclear crisis.
Securities that reflect the outlook for consumer prices have handed investors a 0.02 percent loss in August, an index compiled by Bank of America Merrill Lynch shows, set for the first two-month slide since November 2008 in the aftermath of Lehman Brothers Holdings Inc.’s collapse. By comparison, U.S. inflation-linked debt has increased 6.4 percent since the end of June, while Germany’s has risen 3.3 percent.
The yen has recovered all losses against the dollar since Japan sold its currency on Aug. 4 for the third time in a year, re-approaching a postwar record set in March. A gauge of price trends known as the deflator fell in the second quarter by the most in more than a year, data showed this week, adding to evidence the stronger currency is deepening deflationary pressures that have gripped the country for more than a decade.
“I expect linkers to continue to slump,” said Takeshi Minami, chief economist in Tokyo at Norinchukin Research Institute Co., a unit of Norinchukin Bank, which has $920 billion in assets. “The yen’s appreciation counters rising prices on commodities and adds to downward pressure on the domestic economy by hurting exporters’ earnings, so it has negative influence over consumer prices.”
Japan’s economy shrank at a 1.3 percent annual pace in the three months through June, the third-straight quarter of contraction, the Cabinet Office said on Aug. 15. The deflator dropped 2.2 percent in the period from a year earlier, more than the median estimate of economists for a 1.7 percent decrease.
Deflation, or a general drop in prices, boosts the value of fixed payments from debt. The so-called breakeven rate, or the difference between yields on five-year notes and inflation- linked debt, fell to negative 0.48 percentage points on Aug. 9, the least since April 7, and was negative 0.44 percentage points today. That compared with a positive 1.70 percentage points in the U.S.
Japan’s statistics bureau will change the base year to 2010 from 2005 for the computation of consumer prices starting with July data that’s due for release Aug. 26.
Consumer prices excluding fresh food probably fell 0.3 percent last month, according to estimates by Norinchukin’s Minami.
“Expectations for inflation have barely risen in Japan,” said Hiroto Kuwahara, chief quantitative analyst at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo, one of the 25 primary dealers obliged to bid at government debt sales. “Accordingly, demand for linkers is stagnant.”
The yen traded as strong as 76.61 per dollar in Tokyo today, compared with as weak as 80.24 on Aug. 4 when Japan unilaterally sold its currency. It hit a record 76.25 on March 17 amid speculation Japanese companies would repatriate assets to cope with earthquake and tsunami-related damages. The yen returned to those levels this month as investors sought a refuge from debt crises in the U.S. and Europe.
Japan’s bonds climbed today, with 20-year yields sliding three basis points to 1.82 percent as of 3:09 p.m. in Tokyo. Ten-year bonds yielded 1.02 percent, or 0.82 percentage points more than the growth rate of consumer prices. The so-called real yield on similar-maturity U.S. debt was a negative 1.34 percentage points.
“There is a vicious cycle of the yen appreciation and deflation,” said Masafumi Yamamoto, chief currency strategist at Barclays Bank Plc in Tokyo. “A stronger yen definitely could create deflationary pressure. Higher Japanese real yields are supportive for the yen at the same time, which will likely strengthen to 75 per dollar over the next month.”
A re-emergence of deflation and the yen’s strength may prompt the Bank of Japan to ease policy further. The BOJ expanded an asset-purchase fund, which buys securities ranging from government bonds to corporate debt to stock funds, by 5 trillion yen ($65 billion) on Aug. 4 to total 15 trillion yen.
“Depending on foreign-exchange rates, the economic outlook and most of all consumer prices, pressure on the BOJ for additional easing will certainly increase,” said Shuji Tonouchi, a senior fixed-income strategist in Tokyo at Mitsubishi UFJ Morgan Stanley.
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