Japan's Bonds Complete Second Weekly Decline as Stocks Advance

By Theresa Barraclough

Sept. 13 (Bloomberg) -- Japanese government bonds fell for a second week as the country's equities advanced, reducing demand for the relative safety of debt.

Ten-year yields climbed to a one-month high after the U.S. government took over mortgage finance firms Fannie Mae and Freddie Mac. Lehman Brothers Holdings Inc. said it was seeking a buyer after reporting a record loss, sending the Nikkei 225 Stock Average higher yesterday for the first time in four days.

``The equity market was so bullish and the bond market was so bearish with the Fannie and Freddie news,'' 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 in assets. ``The effect of the Lehman talks is optimistic,'' which weighs on government bonds, he said.

The yield on the 1.5 percent bond due September 2018 added 9 basis points this week to 1.525 percent in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price lost 0.785 yen to 99.783 yen. A basis point is 0.01 percentage point.

Ten-year bond futures for December delivery yesterday were little changed at 137.35 as of the afternoon close at the Tokyo Stock Exchange and the Nikkei 225 gained 0.9 percent.

Treasury Secretary Henry Paulson on Sept. 7 placed Fannie and Freddie in a government-operated conservatorship. The Treasury will provide secured short-term funding to Fannie, Freddie and 12 federal home-loan banks, and buy mortgage-backed debt in the open market.

Ten-year bonds slumped the following day, pushing yields up to 1.55 percent, the highest since Aug. 6.

Inverse Correlation

``The inverse correlation is getting back between Japanese equities and bonds,'' said Keiko Onogi, a debt strategist at Daiwa Securities SMBC Co., one of the 26 primary dealers that are required to bid at auctions, in Tokyo.

Japan's bonds often move in the opposite direction to stocks. Benchmark 10-year yields had a correlation of 0.87 with the Nikkei 225 this month, according to data compiled by Bloomberg. A value of 1 means the two moved in lockstep.

The bonds have handed investors a return of about 1 percent this quarter through Sept. 11, the least among Group of Seven nations, according to indexes compiled by Merrill Lynch & Co. The Nikkei has lost 10 percent in the same period.

Lehman Sale

Lehman Brothers entered into talks with potential buyers of the securities firm after Moody's Investors Service said the company must find a ``stronger financial partner'' and the shares plummeted. Bank of America Corp. is among the possible buyers, the Wall Street Journal said, citing unidentified people. Spokesmen for Lehman and Bank of America declined to comment.

The decline in bonds was limited after the Japanese government yesterday revised down second-quarter figures for gross domestic product.

The downward revision boosted speculation the Bank of Japan may be more inclined to cut interest rates as inflation ebbs, according to Calyon Securities. The economy shrank an annualized 3 percent, compared with a contraction of 2.4 percent originally announced on Aug. 13, the Cabinet Office said yesterday.

``Growth in July to September is expected to be another weak one as both domestic and external demand may remain rather weak,'' which supports bonds, said Susumu Kato, chief economist in Tokyo at Calyon Securities, also a primary dealer. There will be growing pressures for ``the BOJ to cut interest rates when core CPI inflation subsides into 2009.''

Wholesale Inflation

A central bank report on Sept. 10 showed Japan's wholesale inflation rate slowed for the first time in 11 months. Prices companies pay for energy and raw materials rose 7.2 percent from a year earlier after gaining 7.3 percent in July, the bank said. From July, producer prices fell 0.1 percent, the first drop since September 2007.

The central bank will probably leave interest rates unchanged at 0.5 percent this year, according to a Bloomberg News survey of economists and analysts. The estimate puts a heavier weighting on more recent forecasts.

Bonds also declined this week on concern Japan's next premier will increase government spending by issuing additional debt to help finance economic stimulus packages.

Taro Aso, who said spending more to save an economy on the verge of a recession should be the government's top priority, is a front runner to become Japan's prime minister.

``The possibility of Aso winning is high,'' said Kazuya Seki, a deputy general manager at Chuo Mitsui Trust and Banking Co., a unit of Japan's seventh-largest publicly traded bank by assets. Investors are ``conscious of an expansion in fiscal deficit and bonds are not easily bought.''

Aso said last month that the government should consider postponing its goal of balancing the budget by 2011 because the economy is probably in a recession. Japan already has 778 trillion yen ($7.23 trillion) of outstanding debt, which at 147 percent of gross domestic product is the largest among industrialized nations.

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