Goldman Trims Yield Forecast as Surge Hedging Ebbs: Japan Credit

Goldman Sachs Group Inc. retreated from its forecast for a surge in Japanese government bond yields as options are signaling fading concern for a sudden increase in borrowing costs.

The bank cut its 10-year yield outlook by 25 basis points to 0.75 percent this year and to 1 percent by the end of 2015, according to Silvia Ardagna, the New York-based managing director at Goldman Sachs. Ardagna declined to give further comment. The median estimates of analysts surveyed by Bloomberg are 0.72 percent and 0.9 percent respectively.

The benchmark yield more than tripled in less than two months after the Bank of Japan introduced its unprecedented stimulus in April 2013, spurring demand for so-called swaptions. Two-year implied volatility on 10-year interest rate swaps dropped to 33 basis points today, the lowest in data going back to 2009, as the long-term interest rate has been stuck this year in the narrowest range since at least 1990.

“The fall in swaption volatility reflects declining demand for a hedge against a yield surge,” said Akito Fukunaga, director and chief rates strategist for Japan research at Barclays Plc, one of the 23 primary dealers obliged to bid at government bond auctions. “There’s no imminent risk to the JGB market that I can think of at the moment.”

BOJ Governor Haruhiko Kuroda said on July 15 that the long-term interest rate at 0.5 percent is a little low. Japan’s 10-year bond yielded 0.525 percent yesterday, down 21 basis points this year and the lowest globally after Switzerland. A basis point is 0.01 percentage point.

Yield Swings

The benchmark rate reached a record low of 0.315 percent on April 5, 2013, the day after the central bank unveiled its plan to buy about 7 trillion yen ($69 billion) of JGBs a month in an effort to boost inflation to 2 percent. The yield surged to as high as 1 percent in May, before coming down again.

The yen traded at 102.10 against the dollar as of 10:01 a.m. today, 3.1 percent higher this year. It tumbled about 18 percent in 2013.

“One would think massive buying by the BOJ makes policy normalization all the more difficult and heightens the risk of a yield surge,” said Toru Suehiro, a market economist at Mizuho Securities Co., another primary dealer. “The scope of their purchases has been so great that it even offset such concerns.”

Thirty-two percent of economists in a Bloomberg poll taken from July 3-9 expect the BOJ to expand monetary stimulus on October 31, down from 33 percent in a June survey. Policy makers next meet on Aug. 7-8.

Swaption Holdings

“We expect a gradual pick-up in intermediate and long dated Japanese rates, driven by an extension” of the BOJ’s easing program likely to be announced in the fall, Ardagna wrote in a report dated July 25. “A rebalancing of Japanese pension funds and insurance companies’ portfolios could also weigh on the Japanese bond market.”

Dai-ichi Life Insurance Co., Japan’s second-biggest life insurer, held 480 billion yen of swaptions at the end of March, compared with none a year earlier. The contracts are options that grant the right to exchange fixed payments for a floating rate. Sumitomo Life Insurance Co. owned 120 billion yen of such instruments, while Nippon Life Insurance Co., Japan’s industry leader, didn’t hold swaptions.

“We don’t have a predetermined amount in mind, but would like to buy some swaptions cheaply as insurance,” Tetsuya Kikuta, a manager in the investment planning department at Dai-ichi, said in April.

Retirement Funds

Japan’s Government Pension Investment Fund, the world’s biggest pool of retirement savings and the third-largest JGB holder, is shifting into stocks and overseas securities as accelerating inflation increases pressure on domestic investors to seek higher-yielding instruments. Consumer prices excluding fresh food rose more than 3 percent from a year earlier for the third straight month in June, reflecting an increase in the sales tax in April, the statistics bureau said on July 25.

“It’s becoming more and more difficult to envision a yield surge,” said Tomohiro Miyasaka, the Tokyo-based director for fixed-income strategy at Credit Suisse Group AG. “It’s clear JGB supply will tighten even more as BOJ continues with the current quantitative easing program.”

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