Danger Seen in Pension Fund Cuts on Abe Inflation
Prime Minister Shinzo Abe’s push to end deflation is cutting demand for the world’s largest debt pile among its biggest owners just as he ramps up spending.
An auction of 10-year Japanese government bonds yesterday met the weakest demand since August, days after the public pension fund said it was considering reducing its JGB holdings. Investors seeking protection against inflation drove the five- year breakeven rate, a measure of expectations for consumer prices, above 1 percentage point this week for the first time in data going back to June 2009. The similar measure is 2.35 points in the U.S. and 1.25 points in Germany.
Japan’s Government Pension Investment Fund, which oversees 108 trillion yen ($1.15 trillion), will hold talks in April about reducing its 67 percent allocation to domestic notes, President Takahiro Mitani said in a Feb. 1 interview. He said Abe’s targeting of 2 percent consumer-price increases will drive interest rates higher, with 10-year JGB yields unlikely to remain below 1 percent should the economy recover.
“They’re like a big whale; even if they only change direction a little bit, the market impact is huge,” said Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank Ltd., which has 33 trillion yen in assets. “If they are going to change their core portfolio based on that, it’s very dangerous” for the bond market, Sera said.
Bank of Japan Governor Masaaki Shirakawa said yesterday he will step down on March 19, almost three weeks before his term was due, letting Abe hasten the appointment of a chief who will take further steps to defeat deflation.
The yen accelerated losses after Shirakawa’s announcement, sliding 1.4 percent yesterday and touching 93.90 against the dollar today, the weakest since May 2010.
The five-year breakeven rate, derived from the difference between government bond yields and those on inflation-linked debt, was 1 percentage point yesterday, up from negative 0.04 point a year earlier. That compared with the 2 percent inflation goal that the central bank adopted last month after government pressure.
Japan’s consumer prices excluding fresh food have declined an average of 0.2 percent every month over the past decade and have never been above 2 percent for more than a year since 1992.
The so-called core inflation rate will be 0.5 percent in the fiscal year starting April, as the economy grows 2.5 percent, the government said in revised estimates last week.
GPIF, one of the biggest buyers of Japanese government bonds, held 69.3 trillion yen, or 64 percent of total assets, in domestic debt at the end of September, according to its latest quarterly financial statement. That compares with 12 trillion yen, or 11 percent, in Japanese stocks; 9.6 trillion yen, or 9 percent, in foreign bonds; and 12.6 trillion yen, or 12 percent, in overseas stocks.
“JGBs were how we made money over the past 10 years,” Mitani said during the interview. “If the economy gets better, then long-term interest rates like a 10-year yield at less than 1 percent are unlikely.”
A 2.4 trillion yen auction of 10-year notes yesterday drew bids valued at 2.75 times the amount on offer. That’s the lowest so-called bid-to-cover ratio since August and compared with 3.52 at the previous sale. Yields on the securities were at 0.79 percent yesterday, 10 1/2 basis points, or 0.105 percentage point, above a nine-year low touched in December.
Elsewhere in domestic credit markets, Softbank Corp., the Japanese carrier that agreed to buy a $20 billion stake in Sprint Nextel Corp., will sell 300 billion yen in bonds to help finance the acquisition. Softbank will offer debt maturing in four years to Japanese individual investors this month, the Tokyo-based company said today in a government filing.
Japanese corporate notes have handed investors 0.23 percent this year, compared with a 0.10 percent return for the nation’s sovereign debt, according to Bank of America Merrill Lynch index data. Company bonds worldwide have lost 0.7 percent.
The Markit iTraxx Japan index of credit-default swaps for 50 companies dropped to 124 basis points yesterday, the lowest since August 2011, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. A decline in the contracts signals improving perceptions of creditworthiness.
Tokyo Electric Power Co. borrowed 14.8 billion yen from the Development Bank of Japan in a five-year, 0.94 percent loan, the utility said in a statement yesterday.
Japan’s liabilities amounted to 983.3 trillion yen at the end of September, government figures show. The nation’s outstanding debt will swell to 245 percent of gross domestic product this year from 237 percent in 2012, the most in the world and twice the ratio for the U.S., according to estimates by the International Monetary Fund.
Interest payments on outstanding bonds and refinancing costs totaling 22.2 trillion yen will make up 24 percent of the budget for the year starting April 1, the government said on Jan. 29. Abe’s administration will spend 10.3 trillion yen for economic stimulus, it said earlier last month.
“Imagine if we did see 2 percent inflation, and over time the average cost of government debt rose say to 2.5 percent,” said Ken Courtis, founding chairman of Next Capital Partners in Tokyo and former vice chairman for Asia at Goldman Sachs Group Inc. “That would mean debt service would swallow like a python virtually all of the national budget.”
An increase in bond yields may prompt Japanese banks to sell JGBs. The lenders, which have been channeling customer deposits into government bonds rather than extending loans as deflation lingers, held 161.2 trillion yen of the notes in December, central bank data showed.
A 1 percentage point increase in yields on the sovereign securities would cause major banks to incur losses of 3.7 trillion yen on their JGB holdings, the BOJ said in its financial system report last year.
“People have started to debate what would happen to interest payments or portfolios of financial institutions when inflation emerges,” said Makoto Noji, a Tokyo-based bond and currency strategist at SMBC Nikko Securities, one of the 24 primary dealers obliged to bid at government debt sales. “We may see that kind of fear materializing next year but it’s too early to worry about it now.”
The yen has weakened more than 14 percent against the dollar since mid-November, when Abe first called for monetary easing by the BOJ to spark inflation. The depreciation tends to spur consumer-price increases by boosting import costs.
The threat of inflation has yet to trigger an increase in bond risk.
The cost to insure the nation’s sovereign debt was 73.22 basis points yesterday, about half of last year’s high of 154.1 basis points, according to CMA.
Even so, the extra yield that investors demand to own Japan’s 30-year bonds rather than five-year notes is 184.6 basis points, near the highest since March 2010, amid concern the nation’s fiscal health will worsen in decades ahead.
While Abe’s measures to spur inflation may cause interest rates to rise, that won’t damage the economy, said Koichi Hamada, a retired Yale University professor who’s advising Abe on choosing a new central bank chief. A run-up in other asset prices will “compensate for the loss of bond values.”
“Some people will lose because there is capital loss, but along with that the stock market will boom and the yen will devalue so foreign assets will increase,” Hamada said in an interview yesterday. “In terms of the economy as a whole, we shouldn’t worry too much about capital loss.”