Japan's Notes Complete Weekly Gain as Recession Concerns Deepen

By Theresa Barraclough

Nov. 15 (Bloomberg) -- Japan's five-year notes completed a weekly gain as speculation the global economic slump is deepening boosted demand for government debt.

The securities rose for the third time in four weeks before a government report that may show the world's second-largest economy ground to a halt in the third quarter. Demand for shorter-maturity notes also increased this week on optimism the Bank of Japan will add more money into the financial system, lowering money-market rates.

``The market is expecting short-term money rates to fall next week, so it's a signal for investors to start buying,'' said Takashi Nishimura, an analyst in Tokyo at Mitsubishi UFJ Securities Co., a unit of Japan's largest bank by assets. Should last quarter's growth figure come out worse than expected, ``it'll be a very positive surprise for the bond market.''

The yield on the 1 percent note due September 2013 fell 3.5 basis points this week to 0.88 percent in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. Ten- year bond futures for December delivery advanced 0.97 over the five day to 138.37 at the Tokyo Stock Exchange.

Japan's economy failed to grow in the three months ended Sept. 30 from the previous quarter, according to the median estimate of economists surveyed by Bloomberg News before the government report on Nov. 17. Gross domestic product contracted 0.7 percent in the previous quarter.

Extra Funds

Bonds may extend gains next week as local money-market rates decline once the BOJ begins to pay banks interest for their reserves, said Tatsuo Ichikawa, a senior strategist at RBS Securities Japan Ltd. in Tokyo.

The BOJ said last month it will start paying 0.1 percent interest on banks' reserves, encouraging finance companies to lend excess cash to the central bank. The payments will also stop the overnight lending rate falling below 0.1 percent, allowing for the increased provisions of liquidity. The Federal Reserve adopted a similar measure on Oct. 6.

``Usually banks provide liquidity to each other, but as it's not working, the BOJ is stepping in,'' Ichikawa said. ``Now investors are providing liquidity to the BOJ and in turn, the BOJ is providing liquidity to investors. This may lead to a lower repo rate, which is positive for bonds.''

Japan's overnight call loan rate declined to 0.28 percent yesterday, from 0.315 percent on Nov. 13, according to broker Tokyo Tanshi Co.

Stock Gains

Ten-year bonds declined yesterday, with yields rising 2 basis points to 1.50 percent, as a rally in stocks lured some investors to sell fixed-income assets.

The Nikkei 225 Stock Average advanced 2.7 percent, snapping three days of losses, after U.S. shares surged the most in two weeks on Nov. 13.

Japan's bonds typically move in the opposite direction to stocks. Benchmark 10-year yields had a correlation of 0.7 with the Nikkei this month, according to data compiled by Bloomberg. A value of 1 would mean the two moved in lockstep.

Demand for longer-dated bonds also waned on concern the government will sell more debt to fund plans to boost the nation's economic growth.

``Concern of additional issuance is strong'' and investors are in no rush to buy bonds, said Akihiko Inoue, an analyst in Tokyo at Mizuho Investors Securities Co., one of the 24 primary dealers required to bid at government debt sales.

Stimulus Package

Japanese lawmakers last month approved a 1.8 trillion yen ($18.5 billion) supplementary budget as part of a stimulus package to spur economic growth. Prime Minister Taro Aso Oct. 30 promised to pump an additional 5 trillion yen into the economy.

A ``couple of trillion yen'' of extra bond sales ``is fine, but a two-digit figure will have a negative impact on the Japanese market,'' said Yuuki Sakurai, general manager of financial and investment planning at Fukoku Mutual Life Insurance Co., which manages the equivalent of $54 billion in assets in Tokyo.

Inflation-linked bonds worldwide are yielding more than conventional debt, signaling the global economy faces the risk of deflation.

``The deepening recession, emerging speculation of deflation risk and declining risk-taking ability of financial institutions should outweigh supply concerns,'' Tomoko Fujii, head of Japan economics and strategy at Bank of America Corp. in Tokyo, wrote in a report on Nov. 13. ``Banks will have little choice but to boost investments in safe assets like JGBs.''

The extra yield 10-year conventional Japanese bonds offer over similar-maturity inflation-linked debt, known as the breakeven rate, was at minus 160 basis points yesterday, according to data compiled by Bloomberg.

The U.S. five-year breakeven rate was minus 48 basis points and the three-year U.K. breakeven spread was minus 33 basis points on Nov. 13. A negative breakeven inflation rate reflects investor expectations for declining consumer prices over the life of the security.

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