Pimco Favors JGB Linkers as Abe Aims for InflationMariko Ishikawa and Shigeki Nozawa
Pacific Investment Management Co., operator of the world’s biggest bond fund, says inflation-linked bonds are a good play in Japan’s debt market as Prime Minister Shinzo Abe plans wide-ranging stimulus to stoke economic growth.
So-called linkers returned 2.9 percent in the past three months on an annualized basis, extending gains from their best year on record, according to Bank of America Merrill Lynch index data. Non-indexed Japanese government bonds of similar maturities climbed less than 0.1 percent by the same measure, while U.S. linkers lost 1.2 percent, the data show.
Japan’s Ministry of Finance is considering resuming linker sales that have been suspended since August 2008 amid deflation. While Pimco doesn’t believe Abe will be able to stoke a prolonged increase in consumer prices, the fund thinks linkers are “cheap” because the market is underestimating the effect of a planned doubling of the sales tax.
“The ultimate risk for JGB investment would be a transition to inflation in the Japanese economy rather than sovereign credit risk,” Tomoya Masanao, the head of portfolio management for Japan at Pimco said in an interview in Tokyo on Jan. 7. “Bank of Japan policy will become more reflationary and fiscal policy more expansionary.”
Abe has said ending deflation, which weighs on growth by dissuading consumer spending, is the most urgent issue for his nation along with currency strength that hurts exporters. He’s aiming to establish a policy accord with the BOJ to set a 2 percent target for annual consumer price gains, twice the central bank’s current goal. Pimco is taking a “cautious view” on JGBs, especially long- and super-long debt, Masanao said.
“BOJ monetary policy is crucial for the 2 percent inflation target and the currency,” Abe said on Jan. 4. “I think the BOJ has to bear responsibility and act upon it.”
Central bank Governor Masaaki Shirakawa has resisted calls to increase the inflation goal, which was stated for the first time in February. He’s set to end a five-year term on April 8, after two deputies exit in March. Chief Cabinet Secretary Yoshihide Suga said yesterday the next governor should see the need for bold monetary easing.
As Abe led his Liberal Democratic Party to power in elections last month, inflation expectations in Japan’s bond market touched the highest on record.
The three-year breakeven rate, the difference between yields on government notes and inflation-indexed securities, was at 0.597 percent today, after touching 0.643 percent on Dec. 25, the most since Bloomberg started compiling the data in April 2011.
The Ministry of Finance asked the nation’s bond dealers in June to seek buyers of linkers in preparation for new issuance which officials said may come as early as the current fiscal year. The ministry, which met with market participants this month, expects demand for those bonds, particularly among foreign institutions, the Nikkei newspaper said on Jan. 7.
Japan’s inflation-linked bonds of all maturities returned 6.3 percent in 2012, the most in the three years they’ve been measured by Bank of America’s index. A broader index of JGBs rose 1.8 percent on the year.
Elsewhere in Japan’s credit markets, West Nippon Expressway Co. hired banks for a sale of 15 billion yen ($170 million) of three-year bonds in early February, according to a statement from SMBC Nikko Securities Inc., which is managing the offering with Mizuho Financial Group Inc.
Japan’s corporate notes have handed investors a 0.15 percent loss in the past month, compared with a 0.67 percent decline for sovereign debt, according to Bank of America Merrill Lynch index data. Company bonds worldwide returned 0.11 percent during the period, the data show.
The 10-year JGB rate fell one basis point to 0.815 percent today, 13 basis points higher than the nine-year low of 0.685 percent reached on Dec. 6. It is still the third lowest globally after bond yields in Switzerland and Hong Kong. One basis point is 0.01 percentage point.
Demand fell for a second month at the Jan. 8 sale of 10-year notes, the first bond auction of 2013. The government’s sales of 30-year debt today drew bids valued at 3.52 times the amount on offer, the lowest since June 2012, ministry data showed.
Abe’s LDP aims for 3 percent nominal economic growth and gives “the highest priority” to stopping persistent falling prices and yen appreciation, according to the party’s website.
He escalated pressure on the BOJ yesterday, calling Shirakawa to a meeting of policy makers and business leaders. The Council on Economic and Fiscal Policy was scheduled for the first time in four years after it was abolished by the previous government.
The yen depreciated 0.3 percent to 88.11 per dollar as of 1:35 p.m. in Tokyo, and touched 88.41 on Jan. 4, the weakest since July 2010. The currency is still about 15 percent stronger than its decade average and reached a postwar high of 75.35 in October 2011.
Abe is under pressure to deliver on his pledges as he faces an upper house election in July and a doubling of the sales tax to 10 percent in 2015. The government may announce an extra budget of about 12 trillion yen for the fiscal year through March 31, the Yomiuri newspaper and Kyodo News said Jan. 7.
“Abe’s policy is close to helicopter money, where the central bank is essentially financing government spending,” said Ryutaro Kono, the chief economist at BNP Paribas SA in Tokyo and whose nomination to the BOJ board was rejected by parliament in April. “Should yen weakness persist, making investments overseas more profitable, that could be a trigger for capital outflow and a JGB crisis.”
Government debt will probably expand to 245 percent of the Japan’s gross domestic product this year, according to estimates by the International Monetary Fund. That’s the highest debt-to-GDP ratio globally and more than twice that for the U.S.
Fitch Ratings Ltd. this week cautioned Japan about its growing debt burden and said an increase in inflation bets could stoke an advance in bond yields. In May, Fitch downgraded Japan by one step to A+ with a negative outlook. Moody’s Investors Services has a Aa3 rating on Japan, while Standard & Poor’s ranks it at AA-.
“The high and rising level of debt increases the risk of some kind of accident,” Andrew Colquhoun, Hong Kong-based head of Asia-Pacific sovereigns for Fitch, said in a Bloomberg Television interview yesterday. In the absence of a “convincing fiscal consolidation plan,” Fitch would “think about taking the rating down,” he said.
Concerns about Japan’s fiscal health and its prospects for inflation are manifesting in the rates on longer-term bonds. The extra yield investors demand to hold 30-year JGBs over 5-year notes climbed to 1.81 percentage points yesterday, the most since March 2010.
“We don’t think the current valuation is sufficient for the risk premium that investors should demand to be compensated for changing policy risks,” said Masanao, who said he favors five- to seven-year government notes. “We need to be cautious as to how much government spending will increase.”