Business / Financial Markets

Rout seen as encouraging Japan banks' flight to U.S. treasuries

by Shigeki Nozawa

Bloomberg

Japanese banks were already returning to U.S. Treasuries before a plunge in global markets made Federal Reserve rate increases an even more distant prospect.

The lenders bought a net ¥855 billion of medium- to long-term foreign bonds in July, and their purchases reached a three-month high in the week of Aug. 9 to Aug. 15, Finance Ministry data show. That marked a reversal after they sold a net ¥5.2 trillion in the three months to June, about 12 times more than a year earlier.

“The bias on foreign bonds is to buy,” said Makoto Noji, senior interest rate strategist at SMBC Nikko Securities Inc. in Tokyo. “There’s no question that holdings will rise.”

A worldwide stock market rout prompted traders to reduce bets on the Fed raising rates in 2015, as a strong dollar curbs inflation and China’s slowdown deepens. Yields on 10-year Treasuries fell below 2 percent Monday for the first time since April, while Japanese yields dropped to 0.35 percent as the market turmoil boosted demand for the safest assets.

Domestic banks, including Mitsubishi UFJ Financial Group Inc., are looking for places to park excess cash as an increase in lending fails to keep up with rising deposits. Falling interest rates at home are squeezing lending profits and reducing returns on Japanese government bonds.

The country’s banks resumed selling Japanese sovereign notes in July, offloading a net ¥818.9 billion, after becoming net buyers of the securities for the first time in a year in June, according to Japan Securities Dealers Association data. Lenders have been trimming holdings since the Bank of Japan began an unprecedented bond buying spree in 2013 to spark inflation.

With more than $5 trillion erased from stocks worldwide since China devalued the yuan on Aug. 11, investors are betting the Fed will delay its first rate increase since 2006.

In Tokyo on Monday, futures traders cut the odds to 30 percent that the Fed will raise rates in September. That’s down from a 48 percent chance on Aug. 14. The probability of a December increase fell to 54 percent from 74 percent. The figures are based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase.

“Rates probably won’t rise as fast as initially expected or as much,” said Kenta Inoue, senior foreign bond strategist at Mitsubishi UFJ Morgan Stanley Securities Co., adding that long-term U.S. yields will remain curtailed by weak inflation expectations. As long as a spread remains between Treasuries and JGBs, “they will be an attractive investment.”

Treasuries have returned 0.8 percent this year, while JGBs have lost 0.4 percent, according to Bank of America Merrill Lynch indexes. The difference between yields on 10-year U.S. and Japanese government notes narrowed to 168 basis points late Monday in Tokyo, the smallest in about four months.

Shares of Mitsubishi UFJ, Mizuho Financial Group Inc. and Sumitomo Mitsui Financial Group Inc. all tumbled at least 8 percent on Monday as banks led a plunge in domestic stocks. The benchmark Topix index slid 5.9 percent, the most since May 2013.

Lending abroad has been buoying earnings at the country’s three biggest banks. Tokyo-based Mitsubishi UFJ, the largest, is targeting ¥950 billion in net income for the year ending March, close to the record ¥1.03 trillion it earned last year. Mizuho and Sumitomo Mitsui both forecast profit will climb slightly this year.

Japanese investors owned $1.2 trillion in Treasuries as of June 30, more than any other country apart from China.

“We can consider U.S. Treasuries a buy,” said Eiichiro Miura, chief portfolio manager at Nissay Asset Management Corp. in Tokyo, adding that he expects 10-year rates within a range of 2 percent to 2.5 percent. “They have good yield for Japanese investors.”

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