Abenomics Charm Fades as Yields Signal Headwinds

Japan’s bond investors are mirroring voters in turning away from Prime Minister Shinzo Abe.

The nation’s implied forward yield, an indicator of traders’ expectations for the 10-year note rate in 2016, fell to 0.83 percent on July 29. That’s the lowest since the Bank of Japan announced record stimulus in April 2013, suggesting reduced bets that an improving economy will depress demand for the safety of sovereign debt.

BOJ Governor Haruhiko Kuroda’s outlook for the 2 percent inflation goal to be met around 2015 contrasts with market indicators signaling price growth of 1.2 percent over the next decade. Abe’s approval rating, which soared to 76 percent last year, plunged to the lowest since his election in December 2012 at 48 percent last month, a Nikkei newspaper survey showed.

“There aren’t many signs of the economy recovering,” said Takafumi Yamawaki, the Tokyo-based chief rates strategist at JPMorgan Chase & Co. “The inflation rate is likely to drop back to around 1 percent, and will certainly be nowhere near the 2 percent goal. Domestic investors are repatriating to JGBs.”

Japan’s benchmark 10-year bond yield, which was at 0.53 percent today, plunged to a record-low 0.315 percent on April 5, 2013, the day after Kuroda unveiled plans to buy about 7 trillion yen ($68 billion) of JGBs a month. The implied forward rate dropped to 0.73 percent the day before, the lowest since at least 2007. It was at 0.83 percent today, compared with 3.17 percent in the U.S.

Even Lower

JPMorgan and Sompo Japan Nipponkoa Asset Management Co. expect the yield to fall below the 0.5 percent mark that Kuroda has said was “a little low.” Tokai Tokyo Securities Co. forecasts a drop to 0.25 percent this autumn. The median estimate of strategists and economists surveyed by Bloomberg News is 0.72 percent at the end of the year.

“The decline in the forward rate is finally catching up to my nominal yield forecast,” said Kazuhiko Sano, the chief bond strategist at Tokai Tokyo, who in May 2012 correctly predicted last fiscal year’s plunge in Japan’s benchmark yield to 0.5 percent. “The drop in the Cabinet’s approval rating will heighten market expectations for additional monetary and economic stimulus.”

Fifty percent of economists in a Bloomberg poll taken July 3-9 expect the BOJ to expand monetary stimulus by the end of January. Policy makers next meet on Aug. 7-8.

Yen’s Impact

While the yen’s 18 percent plunge against the dollar last year helped bolster prices by pushing up import costs, the Japanese currency is up 2.4 percent in 2014. It traded at 102.87 per greenback as of 11:01 a.m. in Tokyo today.

“The bond market doesn’t believe inflation will accelerate to 2 percent,” said Kenro Kawano, chief fixed-income strategist for Japan at Morgan Stanley MUFG Securities Co. “But I think there’s scope for a further increase in core CPI if the yen weakens.”

The BOJ can achieve and sustain stable inflation at 2 percent, board member Sayuri Shirai said in a speech in Singapore on July 23. Monetary policy should continue to support the economy’s recovery, she said.

The bond market is skeptical. The 10-year break-even rate, a gauge for inflation expectations that’s derived from the difference between yields on conventional and index-linked bonds, was at 1.24 percentage points today.

Consumer prices excluding fresh food costs and the effects of a sales tax increase in April rose 1.3 percent in June. The government raised the levy to 8 percent from 5 percent and has yet to decide on whether to boost it as planned to 10 percent in 2015.

Economic Contraction

Gross domestic product will probably shrink an annualized 7.1 percent in the second quarter, the sharpest contraction since the first three months of 2009, according to a Bloomberg poll of economists. UBS AG cut its forecast for the period to an 8.2 percent decline, according to a report dated July 30. The previous estimate was for a 4.3 percent contraction.

“Should inflation continue to slow after autumn, the market will speculate on the possibility of additional easing,” said Shinji Hiramatsu, the senior investment manager in Tokyo at Sompo Japan Nipponkoa, which oversees the equivalent of $11 billion. “Yields could fall significantly lower once additional easing gets priced in.”

(An earlier version of this story corrected implied forward yield figures in second and fifth paragraphs.)

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