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Long-term yields likely to stay high if worst leader for government bonds since '94 comes back

JGB market braces for Abe’s return

by Masaki Kondo and Shigeki Nozawa

Bloomberg

The worst prime minister for Japanese government bonds in almost two decades is poised to return, ousting the best since 2006.

Shinzo Abe, the front-runner to replace Yoshihiko Noda in Sunday’s general election, oversaw a 1.2 percent gain when he was in office for a year through September 2007, the least since a loss in the two months that Tsutomu Hata was in power in 1994. In the 15 months under Noda’s watch, JGBs returned 3.2 percent, the most among the six successors to Junichiro Koizumi, who stepped down in 2006, data compiled by the European Federation of Financial Analyst Societies and Bloomberg show.

Abe and his Liberal Democratic Party are ahead in the polls after he pledged to increase spending and encourage unlimited monetary easing to revive growth in the third-largest economy. Noda staked his career on raising the sales tax to rein in the world’s biggest debt, helping drive bond yields to a nine-year low. Costs to protect JGBs fell by the most of any other leader since data became available in 2004 and are lower than eight nations in Europe.

“Noda has been friendly to the bond market, and he literally risked his political career for Japan’s fiscal consolidation,” Shunsuke Doi, a market analyst in Tokyo at SMBC Nikko Securities Inc., one of the 25 primary dealers obliged to bid at government debt sales, said Wednesday. “An Abe administration would be an unfriendly environment for bonds, and super-long-term yields are more likely to remain high in years ahead.”

Longer-term bonds are signaling concern about Japan’s fiscal health. The yield premium on 20-year JGBs over 10-year securities climbed to 99 basis points on Dec. 5, the highest since 1999. That compares with a gap of 68 basis points for similar-maturity U.S. Treasuries.

Abe’s September 2007 statement for resignation from Japan’s top office made no mention of his economic record except for a growth strategy “centered on innovation and openness.” It listed the upgrade of the Defense Agency to a ministry-level position among his achievements.

Japan’s debt has climbed to 237 percent of its annual economic output, the most in the world, compared with 183 percent in 2007 during Abe’s previous tenure as prime minister, according to data estimates by the International Monetary Fund.

A government auction of ¥2.3 trillion in five-year notes attracted bids valued at 3.54 times the amount on offer Thursday, less than the previous month’s ratio of 4.96 times and the 3.91 times average in the prior 10 sales, according to Finance Ministry data.

Elsewhere in domestic credit markets, Korea Finance Corp. sold ¥20 billion of two-year, 0.58 percent Samurai bonds, Mizuho Financial Group Inc. said Thursday. Samurais are yen-denominated notes sold in Japan by overseas borrowers.

Meiji Holdings Co., a Tokyo-based seller of chocolate and milk, offered ¥20 billion in five-year, 0.325 percent debt, Daiwa Securities Group Inc. said Thursday.

The extra yield that investors demand to own Japanese corporate bonds rather than sovereign securities has fallen 4 basis points this year to 46 basis points Thursday, according to Bank of America Merrill Lynch data. The spread for Samurai notes has dropped 82 basis points to 77 during the period, the data show. One basis point is 0.01 percentage point.

The yen slid to 83.74 per dollar Friday, the weakest since March 21. The Japanese currency has depreciated 6.4 percent in the past month, the worst performer among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes, as Abe called for a 2 percent inflation goal for the Bank of Japan.

The BOJ raised the benchmark interest rate to 0.5 percent in February 2007 during Abe’s tenure, matching the highest level since 1995. It cut the rate back to 0.1 percent less than two years later as the global financial crisis battered exports and weighed on consumer spending.

The BOJ now targets a rate of between zero and 0.1 percent, and has a ¥66 trillion fund to buy assets, such as government bonds. Its board will meet Wednesday and Thursday.

Policymakers have failed to halt deflation since Abe was prime minister. Consumer prices excluding fresh food have fallen 0.1 percent on average every month since 2006, government data show.

Abe’s conservative LDP is set to win almost 300 seats in the 480-seat Lower House in Sunday’s election, Kyodo News reported Thursday, citing its polls of voters. A separate Kyodo poll said Monday that 39.2 percent of respondents favored Abe as the next prime minister, compared with 30.7 percent for Noda.

The LDP is proposing a “large-scale” supplementary budget to stimulate the economy, according to election pledges posted on its website. It also plans to turn the government deficit into a surplus by the year ending in March 2021, excluding debt-servicing fees and revenue from bond issuance.

“The LDP’s election pledges are actually very fiscally contractionary,” Katsutoshi Inadome, a fixed-income strategist in Tokyo at Mitsubishi UFJ Morgan Stanley Securities Co., a primary dealer, said Tuesday. “If Abe follows them word by word, it would boost investor confidence and spur bond buying.”

The cost to protect Japan’s debt from nonpayment for five years has fallen 36 basis points since Noda took office in September last year, data show. The cost of the credit-default swap was almost unchanged when Abe was in power.

Noda was the first prime minister since 1997 to push through legislation to raise the sales tax, setting it on a course to double to 10 percent by 2015. Abe said Sunday that economic conditions next year will determine whether the increase takes effect.

Sentiment among Japan’s large manufacturers slid to a near three-year low, according a quarterly report from the central bank Friday. The BOJ “tankan” index for large companies fell to minus 12 in December from minus 3 in September, a fifth straight negative reading and the lowest since March 2010. A negative figure means pessimists outnumber optimists.

The economy shrank at an annualized 3.5 percent pace in the third quarter after a 0.1 percent contraction in the period that ended June 30, marking the start of a technical recession.

The benchmark 10-year bond yield has fallen 33 basis points during Noda’s tenure and was at 0.725 percent Friday. It touched 0.685 percent on Dec. 6, the lowest since June 2003. The rate rose four basis points when Abe was prime minister. It was around 1.6 percent when he took power.

“While the tax increase is a step forward for Japan’s fiscal consolidation, Noda’s lack of a growth strategy also contributed to the decline in yields,” Makoto Suzuki, a senior bond strategist in Tokyo at Okasan Securities Co., said Wednesday. “The Noda administration has been friendly to bonds, but I wouldn’t say it’s been friendly to Japan overall.”