Bold New BOJ Steps Priced in as Five-Year Rallies: Japan Credit
Bond investors are pricing in five years of dovish monetary policy in Japan as Prime Minister Shinzo Abe calls for a “bold” new leader of the central bank.
Yields on the nation’s five-year notes slid to 0.155 percent yesterday, one basis point from a record low. That caused the so-called butterfly spread, formed by gaps between the 3-, 5- and 30-year yields, to widen to negative 179 basis points, the lowest on a closing basis in data going back to December 2006 and reflecting a faster drop in the middle rate. Similar spreads were negative 188 basis points in the U.S. and negative 143 basis points in Germany.
Abe said on Jan. 13 he wants a Bank of Japan (8301) governor “who can push through bold monetary policy” after Masaaki Shirakawa steps down in April. The yen has fallen to a more than two-year low amid expectations the central bank will increase cash infusions to jump-start growth and defeat deflation. Its asset purchases have already driven yields on one- to three-year notes to less than 0.1 percent, and the five-year rate is collapsing on bets the BOJ will target longer-term notes next.
“The next BOJ governor must be dovish and a worshiper of Abe’s economic policy,” said Shogo Fujita, chief Japanese bond strategist in Tokyo at Bank of America Merrill Lynch. “The BOJ’s purchases will be a positive for maturities shorter than 10 years, while longer-dated debt will reflect the impact of a weaker yen as well as expectations for inflation and growth.”
The butterfly spread, used to show moves in yields relative to higher and lower rates, is calculated by doubling the five- year yield and subtracting the 3- and 30-year rates. The gap was as high as negative 140 basis points in March, and has widened 36 basis points in the past year to negative 177 today.
The spread between five-year yields and the 10-year rate reached a seven-month high of 63 basis points on Jan. 11, after widening for five consecutive weeks.
Abe yesterday discussed monetary policy with academics including Yale University Professor Emeritus Koichi Hamada, who taught Shirakawa at Tokyo University. Hamada said in an interview last month that Shirakawa’s policy of targeting short- term government notes is “very weak.”
The central bank currently buys sovereign securities maturing in one to three years through its asset fund that’s swelled to 76 trillion-yen ($862 billion), about the size of the Netherlands’ annual economic output in dollar terms. The program also targets stock funds and corporate debt. About 40 trillion yen had been spent as of Jan. 10 with the purchases scheduled to complete by year-end.
The central bank is set to adopt the 2 percent inflation target advocated by Abe, doubling its existing goal of 1 percent without setting a deadline for achieving it, according to people familiar with BOJ officials’ discussions. The bank’s board next meets on Jan. 21-22 and may choose to boost bond purchases then, said Tomohiro Miyasaka, the director for fixed-income strategy in Tokyo at Credit Suisse Group AG.
“A further increase in the BOJ’s asset-purchase program will require the extension of maturities that it buys to four or five years,” Miyasaki said.
The central bank may release a joint statement with the government next week setting the 2 percent inflation goal and it could also say it will consider more monetary easing, said Satoshi Shimamura, Tokyo-based head of rates and markets at the investment-strategy department of MassMutual Life Insurance Co.
A government auction of 2.3 trillion yen of five-year notes today attracted bids valued at 3.44 times the amount available, the weakest demand since September, according to Ministry of Finance data.
Elsewhere in Japan’s credit markets, KT Corp. (030200) considered pricing two-year Samurai notes at an extra yield of 30 to 40 basis points above the yen swap rate, a person familiar with the matter said. The South Korean telecommunications company will also consider a spread of 40 to 50 points for three-year debt and 50 to 65 for five-year securities, said the person, who declined to be identified because the information is private. One basis point is 0.01 percentage point.
Samurai bonds, which are yen notes offered in Japan by overseas borrowers, have returned 0.18 percent this year, compared with the 0.17 percent gain for Japanese corporate bonds, according to Bank of America Merrill Lynch data. Company debt worldwide returned 0.06 percent during the period.
Japan’s machinery orders, an indicator of capital spending, climbed 3.9 percent in November from the previous month, the Cabinet Office said today in Tokyo. That was more than the median estimate of 24 economists surveyed by Bloomberg News for a 0.3 percent increase.
The yen tumbled 11 percent last year, the biggest annual slide since 2005, and touched 89.67 per dollar on Jan. 14, the lowest since June 2010. It strengthened 0.8 percent to 88.09 at 12:55 p.m. in Tokyo. A weaker local currency makes Japanese-made products cheaper overseas, helping domestic exporters compete better against rivals.
Abe announced 10.3 trillion yen worth of extra spending on Jan. 11 that he said will create about 600,000 jobs and boost real gross domestic product by 2 percentage points. Japan will issue an additional 7.8 trillion yen in bonds to finance the supplementary budget for the fiscal year ending March 31, the Ministry of Finance said yesterday.
The extra yield that investors demand to hold 30-year debt instead of 5-year notes climbed to 1.85 percentage points yesterday, the most since March 2010 amid concern the government will fail to curb its mounting debt. The nation’s budget deficit is equivalent to 8.6 percent of its economic output, the worst globally after India and Egypt, estimates by the International Monetary Fund show. IMF official Zhu Min said yesterday Japan’s debt burden is becoming “more serious.”
“A failure of Abe’s economic policy will result in massive budget deficits and dysfunctional industrial structures, triggering substantial outflows of funds from Japan,” said Merrill Lynch’s Fujita. “It’s a make-or-break measure. I’m very worried as a bond strategist and also as a person who makes his home in this country.”
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