Japanese 10-Year Yields Set to Drop to 1% as Deflation Deepens

Dec. 1 (Bloomberg) -- Japan’s benchmark 10-year government bond yields may drop by a quarter percentage point to as low as 1 percent, the least in more than six years, by the end of March, according to analysts and economists.

Demand for bonds is likely to increase as the world’s second-largest economy slips further into deflation, smothering demand in an economy analysts say may falter in coming months as global stimulus wanes. The government said Nov. 20 the country is in deflation for the first time in three years after consumer prices dropped for an eighth month in October. Deflation, persistent declines in prices, enhances bonds’ fixed returns.

“Given the mounting deflationary pressure, it’s not strange to think that yields will break the 1 percent level,” said Tokyo-based Seiji Shiraishi, chief economist at HSBC Securities Japan Ltd. “There is a limit to how much recovery can be spurred through economic packages.”

Industrial production rose in October by less than economists estimated in October, a Trade Ministry report yesterday showed, underlining concerns that the economy may slow even after more than 20 trillion yen ($232 billion) in stimulus spending helped it expand for the past two quarters.

Ten-year yields added 1.5 basis points to 1.26 percent yesterday in Tokyo. Investors who buy 10-year debt today would make a 2.7 percent return, should Shiraishi’s predictions prove accurate, calculations by Bloomberg show.

Deepening Deflation

Deflation blighted Japan during its so-called lost decade of stagnation after an asset bubble burst in the early 1990s. Prices excluding fresh food slid 2.2 percent in October from a year earlier after dropping a near-record 2.3 percent in September. Prices excluding both food and energy dropped 1.1 percent that month.

The benchmark 10-year yield slid to an all-time low of 0.43 percent on June 11, 2003, according to data compiled by Bloomberg. Japan’s consumer prices excluding food and fuel fell at an annual 0.3 percent in June 2003, capping 48 straight months of declines.

Ten-year notes offer a real yield, or what investors get after accounting for costs in the economy, of 2.36 percent, compared with similar-dated U.S. real yields of 1.5 percent, adjusting returns in each case for prices excluding food and energy.

“Japan’s CPI will stay negative for some time,” said Yasutoshi Nagai, chief economist at Daiwa Securities SMBC Co. in Tokyo. “Japanese real interest rates are higher than U.S. real yields, which make Japanese bonds attractive. I recommend buying 10-year Japanese bonds.”

The spread 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 1.05 percentage point yesterday, from minus 0.88 two weeks ago.

Inflation Expectations

Inflation-adjusted securities typically yield less than regular bonds because their principal payment increases at the same rate as inflation.

“It’s a good time to buy government bonds,” said Akira Takei, a manager in the international bond investment department in Tokyo at Mizuho Asset Management Co., a unit of Japan’s second-largest bank. “Given deflation, yields have more room to decline.”

Ten-year yields will slump to 1.2 percent by the end of the year, Mizuho Asset’s Takei said.

Demand for bonds is also likely to increase toward the end of the year as Dubai World’s possible default spurs investors to sell off riskier assets and put their money into government debt.

Dubai World, a state-owned holding company struggling with $59 billion of debt and other liabilities, said Nov. 25 it would seek a standstill agreement with creditors and an extension of loan maturities until at least May 30, 2010.

Lower Hurdle

“The hurdle for investors to buy bonds has been lowered following the Dubai report,” said Kazuya Ito, a fund manager in Tokyo at Daiwa SB Investments Ltd., a unit of Japan’s second largest brokerage.

The cost of protecting Dubai government notes from default more than doubled to 647 basis points in three days after Dubai World announced plans to delay loan repayments, according to CMA DataVision prices. The cost of protecting Japanese debt from default stood at 80 basis points at the end of last week.

The swap contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. Dec. 1 (Bloomberg) -- Japan’s benchmark 10-year government bond yields may drop by a quarter percentage point to as low as 1 percent, the least in more than six years, by the end of March, according to analysts and economists.

Demand for bonds is likely to increase as the world’s second-largest economy slips further into deflation, smothering demand in an economy analysts say may falter in coming months as global stimulus wanes. The government said Nov. 20 the country is in deflation for the first time in three years after consumer prices dropped for an eighth month in October. Deflation, persistent declines in prices, enhances bonds’ fixed returns.

“Given the mounting deflationary pressure, it’s not strange to think that yields will break the 1 percent level,” said Tokyo-based Seiji Shiraishi, chief economist at HSBC Securities Japan Ltd. “There is a limit to how much recovery can be spurred through economic packages.”

Industrial production rose in October by less than economists estimated in October, a Trade Ministry report yesterday showed, underlining concerns that the economy may slow even after more than 20 trillion yen ($232 billion) in stimulus spending helped it expand for the past two quarters.

Ten-year yields added 1.5 basis points to 1.26 percent yesterday in Tokyo. Investors who buy 10-year debt today would make a 2.7 percent return, should Shiraishi’s predictions prove accurate, calculations by Bloomberg show.

Deepening Deflation

Deflation blighted Japan during its so-called lost decade of stagnation after an asset bubble burst in the early 1990s. Prices excluding fresh food slid 2.2 percent in October from a year earlier after dropping a near-record 2.3 percent in September. Prices excluding both food and energy dropped 1.1 percent that month.

The benchmark 10-year yield slid to an all-time low of 0.43 percent on June 11, 2003, according to data compiled by Bloomberg. Japan’s consumer prices excluding food and fuel fell at an annual 0.3 percent in June 2003, capping 48 straight months of declines.

Ten-year notes offer a real yield, or what investors get after accounting for costs in the economy, of 2.36 percent, compared with similar-dated U.S. real yields of 1.5 percent, adjusting returns in each case for prices excluding food and energy.

“Japan’s CPI will stay negative for some time,” said Yasutoshi Nagai, chief economist at Daiwa Securities SMBC Co. in Tokyo. “Japanese real interest rates are higher than U.S. real yields, which make Japanese bonds attractive. I recommend buying 10-year Japanese bonds.”

The spread 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 1.05 percentage point yesterday, from minus 0.88 two weeks ago.

Inflation Expectations

Inflation-adjusted securities typically yield less than regular bonds because their principal payment increases at the same rate as inflation.

“It’s a good time to buy government bonds,” said Akira Takei, a manager in the international bond investment department in Tokyo at Mizuho Asset Management Co., a unit of Japan’s second-largest bank. “Given deflation, yields have more room to decline.”

Ten-year yields will slump to 1.2 percent by the end of the year, Mizuho Asset’s Takei said.

Demand for bonds is also likely to increase toward the end of the year as Dubai World’s possible default spurs investors to sell off riskier assets and put their money into government debt.

Dubai World, a state-owned holding company struggling with $59 billion of debt and other liabilities, said Nov. 25 it would seek a standstill agreement with creditors and an extension of loan maturities until at least May 30, 2010.

Lower Hurdle

“The hurdle for investors to buy bonds has been lowered following the Dubai report,” said Kazuya Ito, a fund manager in Tokyo at Daiwa SB Investments Ltd., a unit of Japan’s second largest brokerage.

The cost of protecting Dubai government notes from default more than doubled to 647 basis points in three days after Dubai World announced plans to delay loan repayments, according to CMA DataVision prices. The cost of protecting Japanese debt from default stood at 80 basis points at the end of last week.

The swap contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.