Deflation Driving Up Real Yield Hampers Effort to Weaken Yen: Japan Credit
Japan’s slide back toward deflation means bond investors are getting some of the highest returns among developed nations even with the world’s lowest yields.
Annual inflation slowed to zero in September, meaning investors in the nation’s benchmark 10-year securities receive the full 0.99 percent yield. That’s the highest so-called real yield for any Group of Seven nation except Italy’s 2.79 percent.
The Bank of Japan cut its inflation forecast last week and said it would buy more government bonds to underpin an economic recovery being threatened by the yen’s surge to a postwar record. The government intervened on Oct. 31 to weaken the currency for the third time this year. With the Federal Reserve discussing more steps to spur its economy and Treasuries yielding less than U.S. inflation, Japan’s efforts may not curb the yen’s strength.
“Deflation means the value of a currency rises relative to prices for goods and services, and such a currency tends to appreciate,” said Takeshi Minami, the Tokyo-based chief economist at Norinchukin Research Institute Co., which is a unit of Norinchukin Bank. “Along with deflation, the Bank of Japan’s cautious stance toward monetary easing gives appreciation pressure to the yen. The intervention effect may wear off, depending on stimulus measures by the Fed.”
Comparative Real Yields
The real yield on 10-year U.S. debt was minus 1.83 percent today, compared with minus 2.11 percent in October, a level not seen since 1980. The yen has gained 6.2 percent in the past six months, the best performance among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes.
Japan’s 10-year bond yields, which slid back below 1 percent on Nov. 2, were 0.99 percent today. That’s the second lowest in the world after Switzerland’s 0.92 percent. Investors get to keep all of the yield on Japanese bonds because there’s no inflation. Consumer prices in the nation were unchanged in September from a year earlier, after rising 0.2 percent in August, according to the latest government figures.
The Bank of Japan cut its forecast last week for the inflation rate, excluding fresh food, from 0.7 percent estimated in July. It increased its asset-purchase fund by 33 percent to 20 trillion yen ($256 billion). The fund buys corporate debt, stock funds and government bonds due in two years or less to support prices and increase money flowing into the economy.
“I expect Japan’s inflation rate to remain around or below zero next year,” said Norinchukin’s Minami. “Compared with what other central banks have been doing, I feel the BOJ’s measures are trivial.”
Japan has been battling deflation for more than a decade, with the average annual 0.3 percent decline in prices since 2000 damaging economic growth by prompting consumers to delay purchases. Deflation increases the allure of bonds by enhancing the purchasing power from their fixed payments.
Five-year credit-default swaps on Japanese government bonds were at 107.5 basis points yesterday, down 47.3 basis points from a record reached in October, CMA prices in New York show. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.
The BOJ bolstered stimulus because of concern that a rising the yen and Europe’s debt crisis would hurt Japan’s economy, Governor Masaaki Shirakawa told reporters after a board meeting. The BOJ separately buys government bonds at a pace of 21.6 trillion yen a year.
The Fed announced in September that it will buy $400 billion of Treasuries with a maturity of between six and 30 years and sell the same amount of notes due in three years or less through the end of June 2012. Federal Reserve Bank of New York President William C. Dudley said on Oct. 24 “it’s possible that we could do another round of quantitative easing.”
Fed Chairman Ben S. Bernanke said unemployment is still “far too high” and the central bank may take further steps to boost growth, such as buying mortgage bonds or changing the way it communicates its policy goals to the public, speaking Nov. 2 after a meeting of the Federal Open Market Committee.
The yen had its biggest intraday loss against the dollar in three years after Japan sold its currency on Oct. 31 and Finance Minister Jun Azumi said he will “continue to intervene until I am satisfied.” It may have been a record for a one-day operation based on estimates of accounts at the BOJ.
Flight to Safety
The yen has trimmed losses since then as Greek Prime Minister George Papandreou struggles to hold on to power after Greece’s largest opposition party rebuffed his overtures to form a national government, raising the prospect of elections. Papandreou faces a confidence vote in parliament.
The Japanese currency was at 78 per dollar as of 11:57 a.m. today in Tokyo, after sliding to as low as 79.53 on Oct. 31.
“We could see the yen, regarded as a relatively safe currency, rise even further” should investors’ risk aversion intensify over a deepening European crisis, Bank of Japan board member Sayuri Shirai, said Nov. 2.
Japan’s yen sales may help push yields in the nation lower, according to RuiXue Xu, a strategist at Royal Bank of Scotland Plc in Tokyo. The sales probably totaled 7 trillion yen to 8 trillion yen, leaving the funds in the economy available to purchase bonds, Xu wrote in a report Nov. 2.
Japan acted alone this week in selling yen, following another unilateral intervention worth 4.51 trillion yen in August and a coordinated effort with G-7 nations in March.
“We’re less convinced about the BOJ intervention given it is unilateral unlike the coordinated action in March which had a longer-lasting effect,” Grant Turley, a senior currency strategist at Australia & New Zealand Banking Group Ltd. in Sydney, wrote in an e-mailed response to queries on Nov. 2. “This U.S. dollar bounce against the yen is a little bit temporary and we would be taking advantage of it.”
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