Japanese Five-Year Bonds Complete Weekly Decline on Stock Rally

By Theresa Barraclough

July 26 (Bloomberg) -- Japan's five-year government notes completed a weekly decline for the first time since July 4 as stock indexes rallied, reducing demand for the security of debt.

Five-year yields this week reached the highest since July 9 after the Nikkei 225 Stock Average completed its biggest weekly advance in five months as crude oil prices declined. Bonds also fell after U.S. lawmakers approved a rescue plan for the nation's two largest mortgage-finance companies, easing concerns that financial-market losses will widen.

``In the first half of this week, the financial uncertainty of the financial system peaked out'' weighing on bonds, said Koji Shimamoto, chief strategist at BNP Paribas Securities Japan Ltd. in Tokyo and the top-rated debt analyst in Japan according to Nikkei Veritas. The bond ``market corresponds to the other market and in this case it's the equity market.''

The yield on the 1.3 percent note due June 2013 rose 2.5 basis points this week to 1.14 percent in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price fell 0.119 yen to 100.741 yen. The yield reached as high as 1.22 percent on July 24. Ten-year yields were unchanged at 1.57 percent on the week. A basis point is 0.01 percentage point.

The Nikkei 225 advanced 4.2 percent this week, the biggest weekly rally since Feb. 15. Crude oil futures fell by about 2 percent this week to $125.84 a barrel.

Japan's bonds often move in the opposite direction to stocks. Benchmark 10-year yields had a correlation of 0.78 with the Nikkei 225 in the past three weeks, according to data compiled by Bloomberg. A value of 1 would mean the two moved in lockstep.

Fannie, Freddie

Ten-year bonds fell for three straight days this week after U.S. lawmakers approved a bill that gives Treasury Secretary Henry Paulson authority to bail out Fannie Mae and Freddie Mac, and provides for a federal agency to insure up to $300 billion of refinanced home loans for struggling owners.

The demand for bonds was limited this week on speculation the Bank of Japan will keep interest rates on hold amid signs the global economy is slowing. Five-year yields lost 7.5 basis points to 1.14 percent yesterday.

``There is a possibility that Japan's economy will slip into a light recession,'' Bank of Japan board member Atsushi Mizuno said on July 24 at a news conference.

Japan's exports fell for the first time in more than four years as demand for cars and electronics cooled, the Finance Ministry said on July 24.

The Ifo institute's German business confidence index slipped by the most since the Sept. 11 terrorist attacks, a report showed on July 24. The National Association of Realtors said U.S. home resales dropped to a decade low.

Growth Priority

The BOJ's ``priority is given to growth,'' said Alessio Caldarera, a fixed-income strategist at BNP Paribas Securities Japan Ltd. in Tokyo. ``As corporate profits are still being squeezed, there isn't going to be a chance for the BOJ to hike in reaction to the higher CPI.''

There is an 18 percent chance the central bank will raise its target rate to 0.75 percent from 0.5 percent by Dec. 31, according to calculations by JPMorgan Chase & Co. using overnight interest-rate swaps. The odds were as high as 92 percent on June 11.

The drop in bonds was also driven by concern accelerating inflation will erode the value of the fixed interest debt pays.

Accelerating Inflation

Consumer prices that exclude fresh food rose 1.9 percent in June from a year earlier after climbing 1.5 percent in May, the statistics bureau said yesterday in Tokyo.

The inflation rate exceeded the benchmark 10-year yield for the first time since 1998. Ten-year yields are 33 basis points lower than the index, compared with last year's average of 170 basis points above, Bloomberg data show.

``This could be a turning point for investors and they will think that higher prices are bad for economic growth,'' said Takashi Nishimura, an analyst in Tokyo at Mitsubishi UFJ Securities Co., a unit of the nation's largest bank by market value. ``This is the same thing as what happened in 1998, when the government introduced higher consumption tax, but this time its simply that Japanese consumer are losing purchasing power to the overseas.''

To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.