Japan Bond Demand Drops to Year Low After Yields Bounce Off 0%

  • International buyers may buy notes with basis swaps: Barclays
  • Life insurer demand for super-long debt may wane, NLI says

Japan’s international bond investors are likely to shift from the nation’s longest-dated debt to shorter securities to take advantage of currency swap agreements that boost returns, according to Barclays Plc.

QuickTake Negative Interest Rates

Foreign investors sold bonds with tenors longer than 10 years in June as yields on the debt approached zero, said Naoya Oshikubo, a rates strategist at Barclays in Tokyo. Now they want short-term notes combined with cross-currency basis swaps that allow dollar-based investors to borrow yen at a discount and turn negative yields positive, he said. An auction of 30-year bonds on Tuesday drew the weakest demand in a year.

“They appear to have earned capital gains from longer-dated bonds last month and are likely to steer away from these sectors where yields approach their upper bound around zero,” Oshikubo said. “They are now likely to focus on shorter maturities.”

While Japan’s two-year note yielded minus 0.345 percent as of Tuesday, dollar-wielding global investors are able to use favorable cross-currency basis-swap rates to turn that yield into a fixed coupon equivalent of about 1.5 percent.

Yields on 40- and 30-year bonds were at 0.13 percent and 0.135 percent, respectively, as of 1 p.m. in Tokyo, after coming within five basis points of zero on July 6. The securities rallied for the past five weeks.

The government’s latest sale of 30-year bonds drew a bid-to-cover ratio of 2.64, down from 3.42 at the previous auction of the maturity and the lowest figure since July 2015.

Life Insurers

Foreign investors aren’t the only ones who may be losing their appetite for low-yielding long-term debt. Japan’s life insurers could reduce purchases, providing a floor on yields above zero, said Katsuyuki Tokushima, the chief fixed-income analyst at NLI Research Institute, a unit of Japan’s largest insurer Nippon Life Insurance Co.

“Insurers will buy less and less of these maturities as their core investment,” Tokushima said. “They had to look for returns in super-long JGBs as interest rates were not rising. It is questionable if they would continue to buy even when yields fall into negative territory.”

In April, the nation’s biggest life insurers said they would be seeking returns in risk assets as the Bank of Japan’s stimulus depresses yields.

The central bank’s two-day policy meeting ending July 29 may determine whether long-term yields stay positive, according to Barclays’s Oshikubo. Prime Minister Shinzo Abe’s announcement Monday that he will present a fiscal stimulus plan spurred speculation that the BOJ will expand monetary easing.

“Lingering expectations for more BOJ stimulus this month will keep super-long yields near zero but stop short of falling into the negative,” Oshikubo said. “They lack forces guiding yield below zero with insurers and foreigners staying away at current levels.”

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