Japanese Bonds Complete Weekly Gain on Interest-Rate Outlook

By Theresa Barraclough

Aug. 9 (Bloomberg) -- Japan's government bonds yesterday completed a weekly gain as signs that economic growth is slowing spurred traders to start betting the central bank will cut interest rates this year.

The odds yesterday were 5 percent for a rate cut by year- end from a 3 percent chance on Aug. 7 of an increase, according to calculations by JPMorgan Chase & Co. using swaps. The 10-year yield fell to the lowest in 3 1/2 months yesterday after the government on Aug. 7 said the world's second-largest economy is ``weakening'' for the first time since May 2001, when the country was in a recession.

``Over the past few days the rate hike expectation has receded and now the market is pricing in no move,'' said Tatsuo Ichikawa, a fixed-income strategist at ABN Amro Securities Japan Ltd. in Tokyo. ``This will support the market for the short term. The market is also biased toward the weak growth outlook.''

The yield on the 1.5 percent bond due June 2018 fell 3.5 basis points this week to 1.475 percent, according to Japan Bond Trading Co., the nation's largest interdealer debt broker. Five- year yields declined 6 basis points over the five days to 1.015 percent. A basis point is 0.01 percentage point.

Ten-year bond futures for September delivery rose 0.57 to 137.68 yesterday at the 3 p.m. close at the Tokyo Stock Exchange.

``The economy has been weakening recently,'' the Cabinet Office said in its monthly economic report in Tokyo on Aug. 7, downgrading its assessment for August. In July it had said ``the economic recovery appears to be pausing.''

Stalling Recovery

Economists estimate a government report next week will show Japan's economy shrank in the quarter ended June 30, bringing the country to the brink of its first recession in six years.

``The longest economic recovery period may be over and we have to face the reality,'' said Yuuki Sakurai, general manager of financial and investment planning in Tokyo at Fukoku Mutual Life Insurance Co., which manages the equivalent of $54 billion. Investors ought to buy bonds because ``it's not the time to take chances,'' Sakurai said.

Gross domestic product shrank an annualized 2.3 percent in the three months ended June 30, according to the median estimate of 26 economists surveyed by Bloomberg News. The Cabinet Office will release the report on Aug. 13.

Investors who ``have dollar- or euro-denominated bonds, may try to reduce holdings and put funds back into Japanese bonds,'' Sakurai said. Fukoku may add to its Japanese bond holdings, which account for more than 40 percent of assets, Sakurai said.

Net Sellers

Japanese investors were net sellers of foreign bonds in the week ended Aug. 1, according to Ministry of Finance data based on reports from designated major investors. Domestic investors sold a net 176 billion yen ($1.6 billion) in foreign debt, the largest net sale since June 13.

The gain in bonds was limited this week on speculation 10- year yields at the lowest in more than three months deterred investors such as life insurers from buying the securities.

``In terms of lifers' perspective, 10-year yields are definitely too low,'' said Keiko Onogi, a debt strategist in Tokyo at Daiwa Securities SMBC Co., one of the 26 primary dealers that bid at government debt sales. Investors will ``not buy aggressively from this level.''

Ten-year yields have fallen 42 basis points since reaching an 11-month high of 1.895 percent on June 16 on concern the economy is entering a recession.

Corporate Bonds

Demand for debt was boosted on speculation some investors are switching from riskier assets such as corporate bonds to government securities.

The cost of protecting Japanese corporate bonds from default yesterday rose to the highest in almost three weeks, according to traders of credit-default swaps.

The Markit iTraxx Japan index gained 4 basis points yesterday to 120, according to Morgan Stanley, which is the highest since July 22. The indexes are benchmarks for protecting bonds against default and traders use them to speculate on changes in credit quality. A basis point, or 0.01 percentage point, is worth $1,000 on a swap that protects $10 million of debt from default.

``Holding cash or bonds is the safest this year,'' said Fukoku's Sakurai. ``The most important thing is not to make a loss.''

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