Japan’s Bonds Fall Most in 7 Weeks as Stock Gains Damp Demand

March 28 (Bloomberg) -- Japan’s 10-year bonds completed the biggest loss in seven weeks as stock gains sapped demand for the relative safety of government debt.

Benchmark yields approached a six-week high as optimism the worst of the global financial turmoil is over helped propel the Nikkei 225 Stock Average to its third weekly advance. Bonds also fell on speculation the supply of debt will keep increasing as the government raises record amounts to fund measures to combat the deepening recession.

“Bonds are being sold given stronger stocks and this trend may continue,” said Masaru Hamasaki, a senior strategist at Toyota Asset Management Co., which oversees $3.3 billion. “As long as there are no negative surprises in economic data, bonds are likely not to be bought.”

The yield on the 1.3 percent bond due March 2019 rose 6.5 basis points this week to 1.32 percent at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price fell 0.576 yen to 99.823 yen. The yield yesterday reached 1.325 percent, the highest level since Feb. 10.

Ten-year bond futures for June delivery fell 1.36 this week to 138.21 on the Tokyo Stock Exchange.

The Nikkei 225 advanced 8.6 percent over the five trading days, a fourth week of gains, and touched the highest level since Jan. 9, boosted by a rally in U.S. shares.

‘Rising Pressure’

“The Nikkei will be under rising pressure following U.S. stocks” and that is negative for bonds, said Jun Ishii, a fixed-income strategist in Tokyo at Mitsubishi UFJ Securities Co., a unit of Japan’s largest bank by assets.

Benchmark bonds have handed investors a loss of 0.03 percent in the three weeks through March 26, according to Merrill Lynch & Co. indexes. The Nikkei has surged 22 percent in the same period.

Japanese bonds are headed for a quarterly loss and Treasuries are set for their worst start to the year since 1996 as the governments of the world’s two biggest economies increase debt sales to fund measures to combat the global recession.

“Even though fundamentals remain weak, supply concerns will dominate the bond market,” said Susumu Kato, chief economist in Tokyo at Calyon Securities, a unit of France’s Credit Agricole SA.

Third Package

Japanese Prime Minister Taro Aso, whose approval rating has slumped before elections that must be called by September, is compiling a third stimulus package to add to the amount pledged since he took office six months ago.

The government is likely to pass an additional supplementary budget in June and bond issuance will probably increase by as much as 10 trillion yen ($102 billion), said Koji Shimamoto, chief strategist at BNP Paribas Securities Japan Ltd. in Tokyo, the top-rated debt analyst in Japan according to Nikkei Veritas newspaper.

The last time Japan stepped up bond sales, in the financial year starting in April 2005, 10-year yields surged 45 basis points. A basis point is 0.01 percentage point.

This week’s drop in bonds was tempered after a government report yesterday showed consumer prices excluding fresh food were unchanged in February from a year earlier. An absence of inflation helps preserve the value of the fixed payments of debt.

Japan will experience a general drop in prices, known as deflation, through the first quarter of next year, according to a Bloomberg News survey of economists. Business sentiment may have slid to the lowest level in 34 years in April, a separate Bloomberg survey of economists showed before the Bank of Japan’s Tankan survey on April 1.

‘Huge Impact’

“Deflation will have a huge impact on markets and monetary policy,” said Kazuhiko Sano, chief strategist in Tokyo at Nikko Citigroup Ltd., a unit of Citigroup Inc. Investors should “buy bonds on dips.”

Inflation-linked bonds signal the world’s second-largest economy may enter a period deflation. Ten-year bonds protected against inflation yielded about 2.12 percentage points more than similar-dated conventional bonds yesterday, Bloomberg data show. The securities typically yield less than regular bonds because their principal payment increases at the same rate as inflation.