Disappearing Yield Gap Challenges Azumi Yen Pledge: Japan Credit - BusinessWeek

September 13, 2011, 1:08 AM EDT By Monami Yui, Hiroko Komiya and Kazumi Miura

Sept. 13 (Bloomberg) -- Finance Minister Jun Azumi’s pledge to take “bold actions” on the yen may be put to the test after a rally in overseas bonds reduced their yield advantage over Japanese debt.

Yields on two-year U.S. securities fell to a 19-year low relative to similar-maturity Japanese notes, a gap that has a “relatively high” correlation with the dollar-yen rate, according to Bank of Japan Governor Masaaki Shirakawa. The spread between Japanese and German debt is the narrowest since at least 1990, as the euro plunged to the lowest level in a decade against the yen.

Gains in Japanese bonds have been outpaced by those in the U.S. and Germany amid speculation Greece will default and the Federal Reserve will signal plans to buy longer-dated debt at a meeting starting Sept. 20. Investor demand for a refuge has intensified since last month, when Japan’s biggest currency intervention in seven years failed to stop the yen from appreciating to a postwar record.

“It’s hard to draw a picture of how the yen could weaken unless international interest-rate spreads widen,” said Tomoko Fujii, a senior foreign-exchange strategist at Bank of America Merrill Lynch in Tokyo. “It’s also the fact that intervention may not be enough to change the trend.”

Azumi ended his first Group of Seven meeting this past weekend, saying he “gained an understanding” with his counterparts on a pledge to stem the advance in his nation’s currency.

‘Bold Actions’

“We will continue to closely monitor developments and we will take bold actions, especially against speculative trading,” Azumi said after G-7 finance chiefs met in Marseille, France. “No one was opposed to my explanation.”

The spread between two-year Japanese and Treasury yields shrank to 2.78 basis points on Sept. 9, the least since January 1992, when the difference reached minus 23 basis points. The gap was at 5.8 basis points today, compared with the 11 basis-point level on Aug. 4 when Japan intervened to weaken its currency for the third time in the past 12 months. It was above 60 basis points as recently as April.

The yield spread between Germany and Japan’s two-year notes shrank to 25 basis points Sept. 9, the narrowest in Bloomberg data going back to 1990, and down from 171 in May.

Damage to Exporters

Japanese data last week showed that gross domestic product contracted in the second quarter by more than the government estimated, highlighting the yen’s threat to an economy that’s still reeling from the effects of a record earthquake in March. A stronger currency reduces the value of overseas earnings at exporters when repatriated.

Shares of Toyota Motor Corp., the world’s biggest carmaker, have lost 18 percent this year compared with a 17 percent plunge in the benchmark Nikkei 225 Stock Average.

The yen’s gains cut Toyota’s first-quarter operating profit by 50 billion yen ($649 million), the company said last month. Every 1 yen gain against the dollar cuts Toyota’s operating profit by 34 billion yen, according to the company’s full-year outlook.

The rising yen boosted Japan’s overseas capital investment compared with similar spending inside the country, with the ratio climbing to 6.5 times in the fourth quarter, the highest level since the three months ended in September 2008. It was 6.3 times in the January-March period.

‘Way Out’

Bank of Japan board members expressed concern that currency gains may spur companies to move factories abroad, according to minutes released yesterday of the central bank’s Aug. 4 meeting.

“Should domestic demand decrease while the strong yen proceeds, it’s natural for Japanese companies to look to find a way out in the overseas market,” said Satoru Ogasawara, vice president of economics research in Tokyo at Credit Suisse Group AG. “Facing a global economic slowdown, Japan needs fiscal and monetary policies to avoid excessive gains in its currency.”

Japan sold 4.51 trillion yen on Aug. 4 to weaken the currency, the nation’s biggest currency-market intervention on a monthly basis since 2004. The yen went on to reach a postwar high of 75.95 per dollar on Aug. 19. The yen advanced at least 0.7 percent against all 16 of its major peers in the past week, and increased 2.5 percent, the best performer among 10 developed nation-currencies tracked by Bloomberg Correlation-Weighted Currency Indexes.

Treasuries have surged, with 10-year yields reaching a record low of 1.877 percent, amid speculation the U.S. central bank will embark on more easing as early as this month.

Europe’s Debt Woes

Fed officials gather for a two-day meeting on Sept. 20 that was extended from the one day originally scheduled to “allow a fuller discussion” of the economy and the central bank’s possible policy response.

Japan’s 10-year yield was unchanged at 0.995 percent today, above its low on the year of 0.97 percent on Aug. 19.

Concern that European policy makers may fail to contain the region’s debt crisis also increased demand for the yen as a haven, driving the currency yesterday to the strongest since June 2001 against the 17-nation euro.

Officials in German Chancellor Angela Merkel’s government are debating how to shore up the nation’s banks in the event that Greece fails to meet the budget-cutting terms of its aid package and is unable to get a bailout-loan payment, three coalition officials said on Sept. 9. Lars Feld, a German government adviser, said on Bloomberg Television yesterday that the July decisions taken by European leaders “won’t suffice” to save Greece from default.

‘Downside Risks’

European Central Bank President Jean-Claude Trichet said last week “downside risks” to the region’s economy have intensified, sparking speculation the central bank may lower rates after boosting them two times this year to 1.5 percent.

Credit-default swaps insuring Japan’s sovereign debt for five years traded at 35.5 basis points more than Germany’s on Sept. 12, compared with this year’s high of 72.5 basis points on March 16, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Japan’s central bank kept its benchmark interest rate at a range of between zero and 0.1 percent on Sept. 6. It also left unchanged a 15 trillion-yen asset-purchase program that buys government bonds, corporate debt and stock funds.

“The BOJ will probably announce some measures to combat gains in yen at its meeting in October,” said Akito Fukunaga, chief rates strategist at the brokerage unit of Royal Bank of Scotland Plc in Tokyo. “Given there is little room for Japan’s short-term yield to fall, it’s impossible to widen the gaps against U.S. and German debt. A strong yen is inevitable in the long run.”

--Editors: Rocky Swift, Jonathan Annells.

To contact the reporters on this story: Monami Yui in Tokyo at myui1@bloomberg.net; Hiroko Komiya in Tokyo at hkomiya1@bloomberg.net; Kazumi Miura in Tokyo at kmiura1@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net

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