Japan's Bonds Complete Weekly Gain as Stocks Slump on Slowdown

By Theresa Barraclough

Aug. 2 (Bloomberg) -- Japan's 10-year bonds completed a weekly gain as local stocks slumped following a U.S. report that showed the world's biggest economy grew less than economists expected last quarter.

Benchmark yields fell to a three-month low yesterday as the Nikkei 225 Stock Average declined the most in three weeks, luring investors to the relative safety of debt. Bonds also advanced as Japanese government reports this week showed wages fell, unemployment climbed to the highest in almost two years and industrial output declined.

``The market is focusing on the downside risks to the economy and the uncertainty in the financial system,'' 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 newspaper. ``The Bank of Japan has been making a point of industrial production, which suggests the Japanese economy is already in a recession.''

The yield on the 1.7 percent bond due June 2018 fell 6 basis points this week to 1.51 percent in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price rose 0.520 yen to 101.632 yen. The yield dropped 2 basis points, or 0.02 percentage point, and touched 1.505 percent yesterday, the lowest since April 24.

Ten-year bond futures for September delivery rose 0.78 this week to 136.72 on the Tokyo Stock Exchange and the Nikkei 225 Stock Average fell 1.8 percent.

Japanese bond yields often move in the same direction as stocks. Benchmark 10-year yields had a correlation of 0.80 with the Nikkei 225 in the past two weeks, according to data compiled by Bloomberg. A value of 1 means the two moved in lockstep.

Slower Growth

The U.S. economy grew at a 1.9 percent annualized rate in the three months to June 30, the Commerce Department said in Washington on July 31, less than the median projection of 2.3 percent in a Bloomberg News survey.

The Japanese economy may have contracted last quarter 1.6 percent from a year earlier, Tomoko Fujii, head of Japan economics and strategy at Bank of America Corp., wrote yesterday in a research note. The government will release the data Aug. 13.

Given ``the negative impact of higher energy and food prices on real income and spending, there should be room for modest declines in JGB yields,'' Tokyo-based Fujii wrote.

Benchmark bonds completed a monthly gain on July 31 after the Labor Ministry said monthly wages dropped for the first time this year in June, declining 0.6 percent from a year earlier.

Industrial Output

Factory output contracted 0.8 percent in the three months ended June 30, the first back-to-back decline since 2001, the Trade Ministry said July 30. The jobless rate unexpectedly climbed to 4.1 percent in June, from 4 percent in May, the statistics bureau said July 29.

Gains in government securities were limited this week on speculation inflation will keep accelerating, eroding the value of the fixed payments from debt.

Food and fuel prices are rising faster than wages, squeezing household budgets and causing consumer sentiment to drop to the lowest level in at least 26 years last month. Core consumer prices climbed 1.9 percent in June, the most in a decade, the government said last week.

``Inflation will remain a sub-theme,'' weighing on bonds, said Naka Matsuzawa, chief strategist at Nomura Securities Co. in Tokyo. ``Once the economic outlook settles, then the focus will turn back to inflation.''

Breakeven Rates

The extra yield paid by 10-year conventional government debt compared with similar-dated inflation-linked bonds fell to 26 basis points yesterday from 39 basis points two weeks ago, according to Bloomberg data. The so-called breakeven inflation rate reflects investor expectations for average annual increases in the consumer price index over the next decade.

The Ministry of Finance will sell 500 billion yen ($4.65 billion) in 10-year inflation-linked bonds on Aug. 7.

Five-year yields fell to the lowest in two weeks yesterday as the odds the Bank of Japan will raise interest rates this year dropped to 8 percent, interest-rate swaps show. The five-year yield slid 6.5 basis points this week to 1.075 percent.

The probability the central bank will increase its target rate to 0.75 percent, from 0.5 percent, was 10 percent on July 31, according to calculations by JPMorgan Chase & Co. using overnight interest-rate swaps. That's down from as high as 92 percent on June 11.

Investors should buy Japan's shorter-dated notes and sell longer-maturity bonds, BNP's Shimamoto said.

The difference in yield between two-year and 10-year debt was 75 basis points yesterday, compared with 81 basis points two weeks ago, according to data compiled by Bloomberg. The gap is likely to widen to 84 basis points by the end of September, according to a Bloomberg News survey of economists and analysts.

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