U.S.-Japan Yield Spread Shrinks as Morgan Stanley Sees Narrowing

The difference between U.S. and Japan 10-year yields narrowed to the smallest amount in six weeks as Morgan Stanley said investors should buy Treasuries and sell bonds of the Asian nation.

Treasury 10-year notes yielded 1.94 percentage points more than their Japanese counterparts today, the smallest spread since Aug. 12 based on closing prices. U.S. yields may fall about a quarter percentage point over the next six weeks, Morgan Stanley, one of the 21 primary dealers that trade directly with the Federal Reserve, wrote in a report yesterday. There’s limited room for further declines in Japanese bond yields, the report said.

“They downgraded their forecasts for the economy quite significantly,” Yusuke Ito, who helps oversee the equivalent of $32.5 billion at Mizuho Asset Management Co. in Tokyo said of Fed policy makers. “They have to maintain the policy rate at an usually low level for longer than the market expected. That’s positive for Treasury holders.”

U.S. 10-year yields were little changed at 2.63 percent at 7:06 a.m. New York time, Bloomberg Bond Trader data show. The price of the 2.5 percent note due in August 2023 was 98 7/8. The yield climbed to 3.01 percent earlier this month on speculation the Fed would trim its bond-buying stimulus program. It fell over the past week after policy makers unexpectedly maintained the purchases and cut their outlook for the economy.

Ten-year yields will probably drop to 2.1 percent in the U.S. by year-end and hold at about the current level of 0.685 percent in Japan, he said. Yields on Japanese government bonds have fallen from this year’s high of 1 percent in May to 0.69 percent.

Pension Panel

A panel advising the world’s largest pool of retirement savings said the Japanese government should review its holdings of domestic bonds that make up the bulk of its pension assets.

The interim report from the panel of economists comes as market participants say the 121 trillion yen ($1.23 trillion) Government Pension Investment Fund should increase its holdings of risk assets. Some members of the group recommended adding new assets such as real estate trusts, infrastructure and private-equity investments and commodities, according to today’s report.

Takatoshi Ito, who leads the panel, said in an interview this week that there “was a consensus” to reduce the weighting of domestic bonds, as potential losses on the securities pose a risk for pension funds like GPIF. The fund posted its smallest gain in three quarters in the period ended in June because of record domestic bond losses. Investors anticipate the fund will expand its purchases of foreign equities or bonds to boost profitability.

Treasury Rally

Bloomberg’s Japan Sovereign Bond Index has returned 0.6 percent in September. It gained 1.5 percent in the third quarter, and it is up 1.9 percent this year.

There is “room for the Treasury market to rally further,” Matthew Hornbach and Ankur Shah in New York and Le Ngoc Nhan in Tokyo wrote in the Morgan Stanley report. “The decline in JGB yields has largely played out.”

The Bloomberg U.S. Treasury Bond Index has risen 0.9 percent this month. It is little changed this quarter and down 2.4 percent for 2013.

Fed officials reduced their forecast for gross domestic product growth to 2-2.3 percent for this year, down from a June projection of 2.3-2.6 percent.

Fed policy makers led by Chairman Ben S. Bernanke refrained from reducing the central bank’s $85 billion pace of monthly bond buying after a meeting Sept. 18, saying the U.S. job market needs to improve.

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