Zero Yields Won't Cut It for Japan Brokers Favoring Longer Bonds

  • Medium, long-term bonds are good investments: MUFJ Morgan
  • MOF seen cutting two-, five-year debt sales by 100 billion yen

The message to Japan’s government from brokerages is clear: go easy on the zero-percent debt.

At last week’s meetings with the Ministry of Finance, most primary dealers and investors didn’t object to cutting issuance of medium-term debt in the year starting April 1, with the five-year yields now 0.035 percent. There was appetite for more-frequent sales of 40-year notes that yield 1.53 percent. Demand at last week’s auction of 20-year bonds was the strongest in a year. 

Investors are snapping up longer maturities as a report showed the Bank of Japan’s gauge for measuring progress toward its 2 percent inflation target dropped below zero for a third month. Skeptics say such debt carries a greater risk of losses should the BOJ realize hopes for higher wages and a rebound in oil prices. 

“Medium- to long-term bonds are a good investment destination, with just around 20-years offering the best investment value,” said Katsutoshi Inadome, a senior fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities Co. “Supply will tighten further and exert downward pressures on yields from short- to longer-term maturities.”

The Finance Ministry will probably cut monthly two- and five-year debt sales by 100 billion yen ($811 million) each, putting downward pressure on the yield curve, according to Inadome. Planned annual issuance of the securities dropped by a total of 4.8 trillion yen for the 12 months ending March 2016 from the previous fiscal year.

Super Longs

Some investors have told the ministry that it should increase the frequency of 40-year auctions to six times a year from five now, according to minutes of the meetings. Sales of the debt increased by 400 billion yen this fiscal year.

Foreign demand for Japan’s short-term notes may keep yields near zero, encouraging other investors to move away from the front of the curve, said Mari Iwashita, chief market economist at SMBC Friend Securities Co. in Tokyo. Cross-currency basis swaps show dollar holders seeking to borrow yen for two years enjoyed the biggest discounts since November 2011 on interbank money market rates last month. Yields on two-year notes were at minus 0.015 percent.

“Scrambling for easing money is distorting the Japanese government bond market as domestic players can’t control yields falling to negative levels from overseas fund flows,” Iwashita said. “Investors are inclined to seek carry returns from longer-dated zones.”

Bond Skeptics

Not all strategists are convinced that long-term bonds are ready to rally. Toru Suehiro, a senior economist at Mizuho Securities Co. in Tokyo, said he’s wary of the sector because the Federal Reserve may raise interest rates this month. Tatsuya Ishizaki, an investment and loan group leader at Sompo Japan Nipponkoa Insurance Inc., said any increase in demand will be limited to debt with no more than 20 years to maturity because of the volatility risk and small investor base.

“Yields in other zones may face upward pressures,” Ishizaki said.

The gap between 10- and 40-year yields has widened to 122 basis points from 99 basis points at the end of December, causing the tail of the curve to steepen.

The 20-year debt yielded 1.065 percent, while the 10-year JGB yield was 0.32 percent. Even if demand for longer bonds increases, benchmark yields are unlikely to break the record low of 0.195 percent set in January, according to Inadome at MUFJ Morgan Stanley.

“I don’t expect the 10-year yield to renew this year’s record, ” said Inadome, who forecasts a drop to 0.2 percent in the first half of the fiscal year starting April 2016. “Investors are wary of proceeding to buy when yields fall to low levels after seeing sharp rebounds this year.”

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