Japan’s Bonds Complete Second Weekly Gain on Deflation Concerns

By Theresa Barraclough

Nov. 22 (Bloomberg) -- Japan’s 10-year government bonds completed a second week of gains as speculation increased that a worsening recession will lead to deflation.

Benchmark debt advanced for a third day yesterday as Bank of Japan policy makers unanimously decided to keep interest rates unchanged at 0.3 percent and said they will consider pumping more money into the financial system to prop up an economy that fell into a recession last quarter. Inflation- linked bonds worldwide are yielding more than conventional debt, signaling investors expect deflation to deepen.

If inflation “falls enough it becomes deflation and that is what triggered this bull flattening,” said Guthrie Williamson, portfolio manager in Sydney at Principal Global Investors, which manages $244.9 billion in assets globally.

The yield on the 1.5 percent bond due September 2018 fell 10 basis points this week to 1.4 percent at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price rose 0.862 yen to 100.862 yen. The yield yesterday touched 1.375 percent, the lowest level since Oct. 8.

Ten-year bond futures for December delivery gained 0.93 this week to 139.30 on the Tokyo Stock Exchange. The contracts yesterday reached 140.10, the highest since Sept. 16, the day after Lehman Brothers Holdings Inc. filed for bankruptcy.

Ten-year U.S. Treasury yields declined 54 basis points for the week to 3.20 percent. The yield advantage over Japan’s bonds narrowed to 1.57 percentage points on Nov. 20, the least since at least April 1999, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.

Deflation Risks

Crude oil slid to the lowest since May 2005 as recessions in the U.S., Europe and Japan cut global energy consumption.

“The sharp drop in oil has increased deflationary concerns,” said Eiji Dohke, chief strategist at UBS Securities Japan Ltd. in Tokyo.

The extra yield 10-year conventional Japanese bonds offer over similar-maturity inflation-linked debt, known as the breakeven rate, was at minus 171 basis points yesterday, according to data compiled by Bloomberg.

The U.S. five-year breakeven rate was minus 77 basis points and the three-year U.K. breakeven spread was minus 124 basis points yesterday. A negative breakeven inflation rate reflects investor expectations for declining consumer prices over the life of the security.

U.S. consumer prices plunged 1 percent last month, more than forecast and the most since records began in 1947, a Labor Department report showed on Nov. 20. A Japanese report on Nov. 28 is estimated by economists to show inflation slowed to 1.9 percent in October.

Bond Supportive

“Global deflation has become the main theme,” said Kazuhiko Sano, chief strategist in Tokyo at Nikko Citigroup Ltd., the Japanese unit of the second-largest U.S. bank by assets. Ten-year yields are likely to decline toward 1.35 percent by the end of March, he said.

The Bank of Japan held its key rate at zero from 2001 to 2006 and flooded the banking system with extra cash to encourage lending, spur growth and overcome deflation. Policy makers reduced the target rate to 0.3 percent from 0.5 percent on Oct. 31, the first cut since 2001.

“The emergence of deflation risk and prospects for another BOJ rate cut should be supportive for the JGB market in the next several months,” Tomoko Fujii, head of Japan economics and strategy at Bank of America Corp., wrote in a report on Nov. 20.

There was a 28 percent chance yesterday the central bank will lower interest rates by the end of March, according to calculations by JPMorgan Chase & Co. using overnight interest- rate swaps.

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