Negative Yields in Japan Don’t Look So Bad With Deflation

(Bloomberg) -- If you thought Japan's negative yields don't offer any value, take a look at the nation's fall back into deflation.

The 10-year Japanese government bond yield of minus 0.065 percent turns into a real yield of about 44 basis points, near a three-year high, after accounting for consumer prices. The figure beats the U.S. 10-year real yield of about 30 basis points.

The Bank of Japan last week acknowledged its negative short-term interest rates and its plan to control the yield curve will need more time to push up living costs. It forecast 2 percent inflation won't be achieved until the year ending March 2019. Bondholders are the beneficiaries, with Japan's debt market little changed over the past month, even as Treasuries dropped 0.4 percent, based on the Bloomberg World Bond Indexes.

“Even with the BOJ being vigilant about controlling bond levels, Japanese yields are on a gradual declining path given the lack of conviction that prices will rise,” said Souichi Takeyama, a rates strategist at SMBC Nikko Securities Inc. in Tokyo, a unit of Japan's second-biggest lender. “There is a lack of concern about inflation.”

The government will test demand when it sells 10-year debt Tuesday and 30-year bonds on Thursday.

Japanese consumer prices are falling at a year-on-year pace of 0.5 percent, matching the biggest declines since 2013, giving bondholders reason to stick with the securities at a time when the central bank is trying to hold nominal 10-year yields at about zero. In the U.S., investors get 1.80 percent. Japan's 40-year bond is more attractive at 0.575 percent, or a real yield exceeding 1 percent.

For an article examining Japan's inflation, click here.

“Real Japanese government bond yields are still relatively high because of low inflation,” said Hideo Shimomura, the chief fund investor at Mitsubishi UFJ Kokusai Asset Management, which oversees about $116 billion. “Everyone knows the BOJ cannot meet their inflation target in the foreseeable future.”

At the policy meeting in September, many BOJ board members said that it was possible to control the yield curve, according to the minutes.

The nation's yields are still too skimpy for some investors.

“There's no merit in Japanese bonds,” said Wontark Doh, head of overseas fixed-income investment in Seoul at Samsung Asset Management, which oversees $200 billion and is South Korea's biggest private money manager. “It's a small real yield. It's unlikely the BOJ will increase monetary policy.”

In an international bond fund, Doh holds fewer Japanese bonds than the percentage in the index he uses to gauge performance. His Treasury holdings match the index, he said.

Five Japanese insurers, including Nippon Life Insurance Co. and Japan Post Insurance Co., said in October they plan to cut yen bonds or boost foreign notes in the six months through March 2017.

Appetite for the nation's debt is still strong enough to keep the benchmark 10-year yield at negative levels below the central bank target.

“Japanese inflation will stay around zero in the long term,” said Hideaki Kuriki, a debt investor in Tokyo at Sumitomo Mitsui Trust Asset Management, which oversees about $80 billion. “It's difficult to see the inflation rate going up.” The longer maturities are the most attractive, he said.

--With assistance from Chikako Mogi To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net. To contact the editors responsible for this story: Garfield Reynolds at greynolds1@bloomberg.net, Sandy Hendry at shendry@bloomberg.net, Tomoko Yamazaki, Ken McCallum