Yen Bears Say BOJ Exit Distant as Swaps at ’05 Low: Japan Credit

Interest-rate swaps are signaling the Bank of Japan will lag far behind the Federal Reserve in ending record stimulus, adding pressure on the yen to weaken.

Japan’s two-year swap rates fell to the lowest since July 2005 last week and the discount to similar U.S. contracts reached the highest in more than three years in June, data compiled by Bloomberg show. The yen will weaken 4 percent to 106 per dollar by year-end, according to the median forecast of more than 50 analysts surveyed by Bloomberg News.

The slide in borrowing costs shows investors are confident BOJ Governor Haruhiko Kuroda will maintain record stimulus even as the Bank for International Settlements warns global monetary authorities to avoid delaying an exit from emergency policies. Inflation-linked bonds show expectations for consumer-price increases well below the 2 percent target that Kuroda says could be achieved next fiscal year.

“Exit in Japan is far, far away,” Yusuke Ikawa, a rates strategist in Tokyo at UBS AG, said by phone on June 27. “The swap spread is widening as demand for dollars increases as yields stay high in the U.S. and low in Japan.”

Japan’s two-year swap rates dropped to as low as 0.165 percent on June 26, compared with 0.588 percent for equivalent U.S. contracts. The U.S.-Japan gap widened to 0.458 percentage point on June 17, the most since April 2011. The swap rate is what borrowers pay to exchange their fixed-income interest payments for floating ones.

Inflation Outlook

The yen traded at 101.45 per dollar as of 1:11 p.m. in Tokyo, down 5 percent since the BOJ announced an unprecedented plan to buy about 7 trillion yen ($69 billion) of government bonds a month on April 4, 2013. UBS forecasts the yen will range from 105 to 110 during the second half of this year, according to a research note last month.

Inflation-linked debt shows expectations for annual consumer-price increases of 1.22 percent over 10 years, the lowest outlook since March 25 and below the BOJ’s goal of 2 percent, according to the break-even rate. The gauge has retreated from as high as 1.39 percent on June 3.

Benchmark bond yields declined today after the BOJ’s quarterly Tankan survey showed sentiment among large Japanese manufacturers deteriorated more than economists forecast. Japan’s 10-year yields, the world’s lowest, dropped to 0.555 percent, matching the least since May 2013.

Wider Spread

“Yields are low in Japan as the BOJ continues record easing,” said Hidenori Suezawa, the Tokyo-based financial market and fiscal analyst at SMBC Nikko Securities Inc., one of the 23 primary dealers obliged to bid at government bond auctions. “U.S. yields will rise on speculation the Fed will tighten after it finishes tapering. Spreads with JGB yields will widen, boosting Japanese investments into U.S. debt.”

The yen will weaken beyond the 5 1/2 year low of 105.44 per dollar reached on Jan. 2, should the U.S. 10-year yield rise above 3 percent, Suezawa said. The U.S. benchmark yield was at 2.53 percent yesterday.

The 10-year yield premium of Treasuries over JGBs will climb to the highest level since February 2011 by the end of March 2015, according to the weighted averages of analysts in separate Bloomberg surveys.

“Because Japanese investors can’t get much return on JGBs, they’re boosting buying of higher-yielding foreign debt,” said Sho Aoyama, senior market analyst in Tokyo at Mizuho Securities Co., a unit of Japan’s third-biggest financial group by market value. The U.S. two-year swap “has been rising in the past six months as it starts to price in a Fed rate hike,” Aoyama said.

Japan’s currency will end the year at about 108 yen to 110 yen per dollar, according to Mizuho.

Policy Exit

Fed Chair Janet Yellen said on June 18 policy makers are discussing a new set of principles to guide an eventual exit from record easing and expects to announce them later this year. The central bank trimmed bond-buying by $10 billion for a fifth straight meeting in June, to $35 billion a month, keeping on pace to end the program late this year.

Kuroda said last month premature discussions on the BOJ’s exit strategy could confuse markets. BOJ officials are considering keeping a large balance sheet even after achieving 2 percent inflation, according to people familiar with the discussions. Policy makers would use cash from maturing debt to buy long-term government bonds, the people said, asking not to be identified because the talks are private.

“A BOJ exit is unlikely until April next year when they next announce their updated economic and inflation forecasts,” said Takuro Nishida, a deputy manager, who helps to oversee about $20 billion of assets at Nipponkoa Insurance Co. “The BOJ has plenty of ways to exit without spurring yield spikes.”

The yen will end March at 105 to 110 against the dollar, according to Nipponkoa.

*T *T

Before it's here, it's on the Bloomberg Terminal.