JGB Bubble Seen Growing by Bank of America on BOJ: Japan CreditMasaki Kondo, Mariko Ishikawa and Yumi Ikeda
A bubble forming in the Japanese government bond market risks further expansion as central bank purchases shield the notes from a global rout, according to Bank of America Merrill Lynch and Mizuho Securities Co.
The Bloomberg Japan Sovereign Bond Index climbed 1.45 percent in the quarter ended Sept. 30, the biggest gain among Group of 10 countries after the 1.54 percent increase in Italy’s debt. Benchmark 10-year JGB yields were the lowest in the world at 0.655 percent today and compared with 2.64 percent for similar-maturity U.S. Treasuries.
Bank of America forecasts 10-year JGB yields will fall to as low as 0.5 percent in the first half of next year while Tokai Tokyo Securities Co. says they may touch a record low of 0.25 percent as the Bank of Japan buys more than 7 trillion yen ($71 billion) of bonds a month to defeat deflation. A JGB bubble could set the stage for a gain in interest rates later if inflation accelerates in Japan or investors lose confidence in the nation’s fiscal health, according to Bank of America.
“JGBs are in the midst of a bubble and because yields are suppressed by the BOJ’s powerful easing, they may start to climb when the stimulus is removed,” said Shuichi Ohsaki, a rates strategist in Tokyo at the U.S. bank, which is one of the 23 primary dealers obliged to bid at Japanese government debt auctions. “We have quite a bullish view on the Japanese economy and expect the BOJ to end its zero rate policy around mid-2016.”
A quarterly report today from the central bank showed that corporate confidence is improving. The BOJ’s Tankan index of sentiment among large manufacturers rose to 12 in September from 4 in June. That was the highest reading since 2007, and compared with the median estimate of 7 from 30 economists surveyed by Bloomberg News.
Japan will raise the consumption tax to 8 percent from 5 percent in April as planned, Prime Minister Shinzo Abe said today in Tokyo after studying the Tankan figures. He is also poised to unveil a stimulus plan to counter any economic damage from the levy increase. Ten-year JGB yields touched 0.655 percent, the lowest since May 10, after Abe’s tax announcement.
The government will compile a 5 trillion yen fiscal package, according to the median estimate of economists surveyed by Bloomberg. Most analysts in a separate poll expect the BOJ to add to easing in the first half of next year.
“The current yield levels will continue to be justified by abnormal monetary policy taken in response to the abnormal situation,” said Koichi Kurose, the chief economist in Tokyo at Resona Bank Ltd. Consumer prices had been falling for more than a decade before the BOJ began its easing program in April to target 2 percent annual inflation.
Elsewhere in Japan’s credit markets, SoftBank Corp. registered to sell as much as 500 billion yen of bonds, according to a filing yesterday with the Ministry of Finance. The Tokyo-based company founded by billionaire Masayoshi Son bought a controlling stake in Overland Park, Kansas-based Sprint Corp. for $21.6 billion in July after winning a bidding war.
Japanese corporate notes handed investors a 0.23 percent gain last month, compared with a 0.54 percent return on sovereign debt, according to Bank of America Merrill Lynch index data. Company bonds worldwide earned 0.82 percent.
A government auction of 2.2 trillion yen of 10-year notes today attracted drew bids valued at 3.74 times the amount available, the highest ratio this year, Ministry of Finance data showed. That suggested demand was strong for the benchmark debt at its first offering in the second half of the fiscal year.
The nation’s 10-year note yield touched a record low of 0.315 percent on April 5, the day after the BOJ unveiled the unprecedented bond-buying program. It then climbed to a one-year high of 1 percent on May 23 before sliding again.
Bank of America forecasts the yield will range from 0.5 percent to 1.15 percent in the fiscal year starting April 1, according to a report dated Sept. 12. In contrast, Tokai Tokyo sees about an even chance that the yield will touch 0.25 percent during the period.
“Japan’s growth potential will continue to deteriorate, so it’s no surprise that yields are where they are now,” said Kazuhiko Sano, the chief bond strategist at Tokai Tokyo. But, “we’ll only know it’s a bubble after it bursts.”
Industrial production in Japan fell 0.7 percent in August from the previous month, while retail sales rose 0.9 percent during the period, according to trade ministry data released yesterday. Both figures were less than the median forecasts of economists in Bloomberg surveys.
The yen has strengthened 1.1 percent against the dollar since the end of June, and traded at 98.08 per greenback as of 1:47 p.m. in Tokyo. The Topix index of Japanese shares climbed 5.3 percent in the July-September period, the fourth quarterly advance, even as the currency appreciation risked weighing on local exporters’s earnings.
Mizuho says the JGB rally is at odds with the gains in the equity market.
“Bond yields aren’t consistent with stock prices,” said Tetsuya Miura, the chief bond strategist at Mizuho Securities, a primary dealer. “There are only two options left for Japan: either the nation will end deflation, the economy expands on a nominal basis, and tax revenue increases, or it will remain in deflation and fiscal risk premiums will rise.”