Growing ‘butterfly gap’ shows 10-year JGBs top bet


Investors are favoring Japan’s 10-year notes over both shorter- and longer-term debt on prospects the central bank will succumb to lawmaker calls to buy a wider spectrum of debt to support the economy.

The so-called butterfly spread formed by the gaps between 5-, 10- and 20-year bond yields reached negative 15 basis points on April 17, the widest since Feb. 16, two days after the Bank of Japan last increased its debt purchase plan and set an inflation goal. The measure is used to show moves in a yield relative to higher and lower rates. A similar spread for 5-, 10- and 30-year rates in the U.S. was negative 2.6 basis points.

Economic Policy Minister Motohisa Furukawa said on Friday that longer debt purchases is “one idea” for the central bank to consider as it meets this week. Ten-year notes are in the relative sweet spot, according to Tadashi Matsukawa, head of fixed-income securities at PineBridge Investments Japan Co., with short-term securities yielding so little and long-term debt in danger if the BOJ succeeds in sparking inflation. “Five-year securities don’t offer enough returns, so investors have no choice but have to buy longer-maturity debt,” Matsukawa said. The narrowing butterfly spread “signals a bull market.”

The yield on Japan’s benchmark 10-year notes slid to 0.93 percent last week, the least since November 2010 and the lowest in the world after Switzerland. Five-year rates fell to 0.275 percent, a level unseen since October 2010. Twenty-year yields stood at 1.72 percent.

The central bank, which will meet again this Friday, added ¥10 trillion to a ¥9 trillion program on Feb. 14 that buys government debt maturing within two years and set an inflation goal of 1 percent. Gov. Masaaki Shirakawa said Wednesday the BOJ “is fully committed to continuing powerful monetary easing” until the target for price gains is achieved.

Prime Minister Yoshihiko Noda is struggling to get approval for a plan to double the nation’s sales tax by 2015 to reduce the government’s deficit. Under pressure from lawmakers, the BOJ may be “willing to concede” to another ¥10 trillion increase in its asset-purchase program, according to Cameron Umetsu, a foreign-exchange strategist for UBS AG in Tokyo.

The BOJ may also widen debt purchases beyond the two-year limit, and its easing stance in relation to the Federal Reserve may push the yen toward the 85 per dollar level within three months, Umetsu wrote in a report Friday.

Shirakawa has warned that the central bank can’t directly underwrite government bonds, a process known as monetization, as doing so could spark runaway inflation. He and his board have kept the BOJ’s asset-purchase program unchanged at the last two policy meetings.

Elsewhere in credit markets, the Japan Housing Finance Agency sold ¥275.5 billion of 1.34 percent notes backed by residential mortgages, according to a statement from Nomura Holdings Inc. last week. The bonds had the lowest yield in the agency’s five-year history, data compiled by Bloomberg show.

Fuji Heavy Industries Ltd., which makes Subaru cars, registered to sell as much as ¥40 billion of bonds, according to a filing with the Finance Ministry. The automaker privately sold ¥4 billion of 1.62 percent five-year bonds in July 2009, according to data compiled by Bloomberg.

The extra yield investors demand to hold Japanese corporate debt instead of sovereign bonds has fallen 13 basis points this year to 63 basis points, or 0.63 percentage point, Nomura Holdings Inc.’s Bond Performance Index shows.

The yen traded at 81.64 per dollar Friday in Tokyo, losing 0.8 percent last week. The Japanese currency has depreciated 8.3 percent so far this year against a basket of nine developed-market peers, according to the Bloomberg Correlation-Weighted Index. It climbed to a postwar high of 75.35 on Oct. 31.

The BOJ sees protecting its own balance sheet as more important than ending deflation and spurring growth, said Heizo Takenaka, a Cabinet minister under former Prime Minister Junichiro Koizumi. Expanding easing is “better than doing nothing,” he said.

Economy Minister Furukawa said last week he hopes the central bank will consider ways to achieve its 1 percent inflation goal.

Note buying by the BOJ has helped bring down yields on two-year government securities to near the upper range of the BOJ’s policy rate of 0.1 percent. Expanded easing may drag 10-year rates lower, while the prospect of inflation keeps yields on super long-term debt relatively higher.

As a bond nears maturity or “rolls down” the yield curve, it is valued at successively lower yields and higher prices. Using the strategy, the security is held for a period of time as it rises in price and is sold to realize the gain. The strategy works when longer maturities yield more than shorter-dated ones.

Those who buy and hold Japan’s 10-year debt for 180 days will get a price gain equivalent to a decline of seven basis points in the yield, the most among securities ranging from two-year to 30-year bonds, according to data compiled by Bloomberg.

Ten-year interest-rate swaps, which exchange a fixed rate with a floating one, slid to as low as 0.93 percent on April 17, the least since October 2010.

Five-year credit-default swaps linked to Japan’s government bonds fell to 93 basis points on April 19, down from a record high of 154.8 basis points in October, according to CME Group Inc.’s CMA. Lower premiums signal improving perceptions of creditworthiness among investors.

More than a decade of deflation has prompted banks to channel customer deposits into state bonds rather than lending. That’s helped the government finance its deficits cheaply, while public debt has climbed to double the size of Japan’s annual economic output. Customer deposits held by domestic banks exceeded loans by ¥164.6 trillion in March, 1.3 percent from a record reached in June, data from the BOJ show. That’s equivalent to $2.02 trillion and compared with $1.65 trillion in the U.S.

“Unless the economic outlook turns decisively positive, households will continue to keep their assets in cash and bank deposits,” said Daisuke Karakama, a market economist at Mizuho Corporate Bank Ltd.. Unlike lending, “bonds are safe and supported by the BOJ’s purchases.”