Japanese Bonds Complete Monthly Gain as Factory Output Declines

By Theresa Barraclough

Nov. 29 (Bloomberg) -- Japan’s 10-year bonds completed a monthly gain yesterday after a government report showed factory output fell more than expected, signaling a recession in the world’s second-largest economy is deepening.

Yields fell to the lowest level since April on speculation demand for longer-dated debt increased as investors matched a month-end change in a benchmark gauge used to check the performance of their portfolios. Bonds also gained as a report showed inflation slowed for a second month, helping preserve the value of the fixed payments from debt.

“Economic data is a support for bonds,” said Naka Matsuzawa, chief strategist at Nomura Securities Co. in Tokyo. Third-quarter “GDP is likely to be in the minus.”

The yield on the 1.5 percent bond due September 2018 fell 8.5 basis points this month to 1.395 percent at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price gained 0.733 yen to 100.905 yen. The yield reached 1.355 percent yesterday, matching the lowest level since April 16.

Ten-year bond futures for December delivery rose 1.40 this month to 139.38 on the Tokyo Stock Exchange.

Japan’s economy will shrink 0.04 percent in the final quarter of 2008 after it contracted 0.4 percent in the three months to Sept. 30, according to the weighted average forecast in a Bloomberg News survey.

‘Deflationary Risk’

Consumer prices excluding fresh food rose 1.9 percent in October from a year earlier, after gaining 2.3 percent in September, the statistics bureau said in Tokyo yesterday. Industrial production fell 3.1 percent, more than the 2.5 percent decline forecast by economists surveyed by Bloomberg.

“The recession is likely to continue through mid-2009,” Tomoko Fujii, head of economics and strategy for Japan at Bank of America Corp. in Tokyo, wrote in a report Nov. 27. “Easing of global market pressure, expectations of deflationary risk and BOJ policy easing expectations should” lead to lower yields.

Inflation-linked bonds worldwide are yielding more than conventional debt, signaling investors expect deflation, or a drop in consumer prices, will worsen.

The extra yield 10-year conventional Japanese bonds offer over similar-maturity inflation-linked debt, known as the breakeven rate, was at minus 195 basis points yesterday, according to data compiled by Bloomberg. The U.S. five-year breakeven rate was minus 72 basis points and the three-year U.K. breakeven spread was minus 191 basis points on Nov. 27.

Reduced Holdings

“We’ll see deflationary pressure on Japan’s economy emerge because of the effect the global financial crisis will have on capital spending,” Economic and Fiscal Policy Minister Kaoru Yosano said at a press conference in Tokyo yesterday. “That’s something we need to be cautious about.”

Even so, overseas investors sold more Japanese government bonds than they bought last week for a 10th consecutive week.

Foreign “investors are reducing risk on the whole,” said Takashi Nishimura, an analyst in Tokyo at Mitsubishi UFJ Securities Co., a unit of Japan’s largest bank by assets. “There is a lot of concern about financial markets and the risk appetite is reduced. We will see a similar trend going forward.”

Overseas investors sold 839 billion yen ($8.81 billion) of Japanese bonds in the week ended Nov. 21, according to figures based on reports from designated major investors released by the Ministry of Finance in Tokyo.

Index Weightings

Nomura Securities Co. will increase the average duration of its Bond Performance Index to 6.31 years from 6.16 years in December, according to the company’s Web site.

“The longer-dated sectors will be strong given the extension trade,” said Kazuhiko Sano, chief strategist in Tokyo at Nikko Citigroup Ltd., the Japanese unit of the second-largest U.S. bank by assets.

Money managers such as Japan’s Government Pension Investment Fund, which runs the world’s largest pool of retirement wealth, use Nomura’s index to help decide their holdings. Duration is a gauge of how much a change in yields affects the price of a bond or debt portfolio.

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