Japan Bonds to Beat U.S. for First Time Since 1999

July 14 (Bloomberg) -- Japanese bonds will beat Treasuries this year for the first time in a decade as the economy shrinks at twice the pace of the U.S., the largest traders in the securities said.

The yield on Japan’s 10-year bond will end 2009 at 1.30 percent, little changed from the three-month low of 1.27 percent set last week, based on the median estimate in a Bloomberg News survey of the 23 primary dealers that bid at government debt sales. Japan’s economy will shrink 5.9 percent this year, versus 2.5 percent in the U.S., a separate survey of banks and securities companies shows.

Traders said the market for Japanese government bonds, so- called JGBs, with 846.5 trillion yen ($9.1 trillion) outstanding, will gain as deflation spreads and loan demand wanes. Banks in the nation such as Mitsubishi UFJ Financial Group Inc. and Mizuho Financial Group Inc., the two largest by assets, own a record 111.9 trillion yen of the securities, the most since Bank of Japan figures started in 1993.

“Buy now,” said Kenro Kawano, a fixed-income strategist at Credit Suisse Group AG in Tokyo, the most bullish of the primary dealers, with a yield forecast of 1 percent. “Deflation pressure will increase. Banks are accumulating JGBs, and the pace is increasing.”

Ten-year government debt will return 0.7 percent through year-end if the survey proves right, according to data compiled by Bloomberg. The yield on the 1.4 percent security due June 2019 rose one basis point to 1.31 percent today. The price fell 0.089 yen to 100.790 yen. A basis point is 0.01 percentage point.

Treasury Yields

Treasury 10-year yields will rise to 3.76 percent by year- end from 3.35 percent today, for a 1.7 percent loss, based on another Bloomberg survey, with the most recent forecasts given the heaviest weightings.

Treasuries and Japanese government bonds have both rallied in the past month as stock declines around the world increased demand for the relative safety of government debt. Ten-year yields in both markets set their highs for this year on June 11. The rate has dropped about 65 basis points in the U.S. since then, versus 25 basis points in Japan, leading companies from New York-based BlackRock Inc. to Franklin Templeton Investments in San Mateo, California, to turn more bullish on their outlook for Treasuries.

The MSCI World Index of stocks fell 7 percent from this year’s high, also made on June 11, as expectations for an economic recovery this year have faded.

Outperforming Treasuries

Japanese 10-year bonds are outperforming Treasuries in 2009, though they pay annual interest of 1.4 percent, versus 3.125 percent for the U.S. securities.

Japan’s government bonds are little changed this year, while Treasuries have lost 3.4 percent, according to indexes compiled by Merrill Lynch & Co. American securities had their worst first half in at least three decades as President Barack Obama increased the marketable debt to a record $6.61 trillion.

The last time JGBs beat Treasuries was in 1999, when they returned 5.12 percent, compared with a loss of 2.38 percent for American bonds, as quickening economic growth caused the U.S. Federal Reserve to raise interest rates. Japan and the U.S. are the biggest bond markets among 35 nations ranked by the Bank for International Settlements in Basel, Switzerland.

Japanese banks are using deposits to purchase bonds as demand for loans slows. Outstanding loans have fallen for three straight months, the longest decline since 2005, according to the central bank.

‘Huge Risk’

“There is a huge risk not holding bonds,” said Tomoya Masanao, an executive vice president in Tokyo at Pacific Investment Management Co. “The growth rate won’t rise much and prices will remain low.”

Pimco increased its bet on Japanese debt “slightly” since the fiscal year started April 1, he said. The company, based in Newport Beach, California, runs the world’s biggest bond fund, the $161 billion Total Return Fund.

The Ministry of Finance plans to increase bond sales to a record 130.2 trillion yen in the current fiscal year to allow Prime Minister Taro Aso to pay for 25 trillion yen in spending he has announced.

Government debt will increase to almost double the size of the nation’s gross domestic product next year, according to the Paris-based Organization for Economic Cooperation and Development.

170 Percent of GDP

Borrowing already amounts to 170 percent of GDP, the most among the Group of Seven industrialized nations, according to Bloomberg data. U.S. debt is equal to 55.9 percent of its economy, the figures show.

Aso, from the Liberal Democratic Party, plans to hold national elections on Aug. 30, legislator Shuzen Tanigawa said yesterday. The premier faces a challenge from the Democratic Party of Japan.

“The LDP or DPJ, regardless the outcome of the forthcoming general election, are likely to hammer out fresh stimulus measures to boost the public support,” said Akitsugu Bandou, senior economist at Okasan Securities Co. in Tokyo. “We have to brace for more debt sales.” Ten-year yields may climb to 1.5 percent by the end of December, he said.

At the start of the year, primary dealers projected yields would increase to 1.7 percent by Dec. 31.

Since then, Bank of Japan Governor Masaaki Shirakawa increased the amount of bonds the central bank buys to 1.8 trillion yen a month from 1.4 trillion to combat the nation’s worst postwar economic recession.

Record Contraction

Shirakawa cut the target for overnight loans between banks to 0.1 percent from 0.3 percent in December. The economy contracted at a record 14.2 percent annual pace in the three months ended March 31.

Consumer prices fell at an unprecedented rate in May, sending the inflation index measuring costs excluding fresh food down 1.1 percent from a year earlier. Deflation, or a general drop in prices, enhances the value of a bond’s fixed payments.

“The Japanese economy may fall into a double-dip recession, and deflationary pressure will strengthen,” said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo. Ueno forecasts 10-year yields will drop to 1.1 percent by Dec. 31.

Treasuries fell this year on speculation investors from outside the U.S., who own more than half of the nation’s debt, will demand higher yields to keep buying. Japan doesn’t face that challenge because about 92 percent of the bonds are held within the country, based on data from the Ministry of Finance.

Deflation to Spread

Yields indicate deflation will spread. The difference between rates on five-year notes and inflation-linked debt, which reflects the outlook among traders for consumer prices over the term of the securities, was negative 1.6 percentage points. By contrast, the figure is positive in the U.S., the U.K., Germany and Italy.

“Investors globally should prefer yen bonds,” said Daisuke Uno, chief bond and currency strategist at Sumitomo Mitsui Banking Corp. in Tokyo, a unit of Japan’s third-largest banking group. “Yen bonds are considered to be safer than U.S. Treasuries” after the first half, he said. Japanese 10-year yields will fall to 1.125 percent by year-end, he said.