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February 18, 2013 9:57 am
What would you do? In the coming fiscal year, about Y25tn of five-year Japanese government bonds will reach maturity. The weighted average coupon on that huge mound of paper, at about 1 per cent, is roughly six times higher than the yields currently available at auctions.
If you are an investor, do you simply bid for six times as much, to keep your income constant? Or do you look to buy more longer-dated bonds with the proceeds, seeking to squeeze out a little more revenue?
Either way, the outcome is bullish for bonds, notes Jun Ishii, chief fixed income strategist at Mitsubishi UFJ Morgan Stanley in Tokyo. And it is one of the main reasons why few are counting on any sustained weakness in Japan’s government bond market this year – even as Shinzo Abe, the new prime minister, cranks up fiscal spending as a means to drive growth and banish deflation.
“Far from there being a sense of heaviness due to increased issuance, there may well be an increased sense of tightness for JGB supply and demand conditions” in the year ahead, says Mr Ishii.
This is the reality of “Abenomics” for the world’s second-biggest bond market. Despite a lot of giddiness in equity and currency markets over policies designed to achieve 1 per cent real and 3 per cent nominal growth in the economy, bond investors have been mostly unfazed.
Up to five years along the curve, already low yields have been pushed even lower by rare back-to-back monetary easings by the Bank of Japan in December and January, and as investors bet that a new BoJ governor in March will take more radical measures under the increasingly close watch of the government.
The five to 10-year sector has also held fairly steady, partly as a result of the determination of banks – the biggest players in the JGB market, holding more than two-fifths of the Y943tn ($10tn) outstanding – to earn more income by moving further up the curve.
“Short- and midterm bonds should be kept in check for some time to come,” says Tomohisa Fujiki, interest-rate strategist at BNP Paribas Securities in Tokyo.
It is only beyond that, in the super-long sector, that there has been a mild sell-off since the old government called an election in mid-November, as investors have mulled the prospects of higher inflation and the risks of looser fiscal policy.
In the fiscal year beginning in April, for example, the finance ministry plans to hold a dozen auctions of 30-year bonds, up from eight this year, says Yuya Yamashita, rates strategist at JPMorgan.
Foreign investors have been particularly keen on so-called “steepener” trades, expecting that, while shorter-term yields will remain anchored by the BoJ, longer-term yields should rise.
The trade has been seen as a “win-win”, says Shogo Fujita, chief Japanese bond strategist at Bank of America Merrill Lynch, noting that the spread between 10-year and 20-year bond yields climbed to its highest level since 1999 at the end of last month.
“The yield curve is trying to tell us that if Japan manages to pull out of deflation, then it is 10 years and beyond that will be affected. If it doesn’t, then the curve will steepen anyway, through lack of fiscal discipline.”
For now, though, many analysts doubt that inflation will erode real returns any time soon. Some note that Mr Abe’s growth targets would be a dramatic reversal for an economy that has shrunk by an average of 0.7 per cent each year, in nominal terms, since 1997.
The most recent monthly survey of bond-market participants carried out by Quick, a data provider, showed that 72 per cent of respondents said 2 per cent inflation – excluding the impact of scheduled consumption tax hikes – would be achieved in the “2016 fiscal year or later”.
Tomoya Masanao, head of portfolio management at Pimco in Japan, says he questions “how credible the 2 per cent target can be, in an economy where potential growth is close to zero and likely to be even lower, because of the demographic deterioration”.
To achieve the target “in a sustainable manner, a lot more aggressive monetary easing will be essential, but the government will also need to deliver on the structural policy front”, he says.
Until economic data starts to suggest that Japan is emerging from its deflationary malaise, bond prices will stay “range-bound”, agrees Le Ngoc Nhan, rates strategist at Morgan Stanley MUFG Securities.
Some overseas hedge funds will continue to buy high-strike options, betting on a surge in long-term yields to 6 or 7 per cent, but it is with less intensity than a year ago.
“The Japan ‘blow-up’ scenario is no longer a popular trade,” he says.
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