News Archive : Japan Real Estate

Monday, November 21, 2005

Japan's Recovery Flashes a Warning to World's Bond Investors

Japan's Recovery Flashes a Warning to World's Bond Investors

Nov. 21 (Bloomberg) -- The prospect of a durable economic recovery in Japan has bond investors wondering if global yields are heading north.

The emergence of the world's second-largest economy from 14 years of stagnation has pushed up Japanese bond yields and share prices. Japanese investors, the biggest international holders of U.S. Treasuries, may bring more funds home unless yields outside the country also continue to rise, traders and investors say.

``If interest rates can rise in Japan, where they have been suppressed by global disinflation for more than a decade, they can rise anywhere,'' said Tony Crescenzi, head bond market strategist at New York brokerage Miller Tabak & Co.

Losses in Japanese bonds, and a resulting rise in global yields, would be felt beyond the fixed-income market. Mortgage rates worldwide would shoot up, possibly undermining home prices in countries such as the U.S. and U.K., where real estate prices have soared. Higher borrowing costs and a decline in property values would slow economies and crimp profit growth, weighing on stock markets.

The yield on Japan's benchmark 10-year bond reached a one- year high of 1.63 percent on Nov. 7. Yields in Japan's government bond market, the world's largest, bottomed at 0.43 percent in 2003. Comparable government securities in the U.S. yield 4.50 percent, while German bunds, a European benchmark, yield 3.53 percent. Bond prices fall as yields rise.

Central banks worldwide can influence whether yields rise. Bank of Japan Governor Toshihiko Fukui said on Nov. 18 that a policy change is possible next year after four years of keeping Japan's benchmark interest rate near zero.

Policy Shift

European Central Bank President Jean-Claude Trichet said on Nov. 18 the ECB is ready to raise rates, for the first time since 2000. Interest rate futures show the U.S. Federal Reserve's series of increases will extend into next year to curb inflation.

For now, equity investors are betting on growth. The Nikkei has risen 35 percent from its 2005 low in May and reached a five- year high on Nov. 18. The U.S. 10-year note's yield is up about 0.6 percentage point from its 3.89 percent low for the year in June. It may reach 5.50 percent in the first quarter next year, said William Kohli, who manages $7 billion in bonds at Putnam Investments in Boston.

``As the Nikkei moves up in price, it signifies growth in the Japanese economy,'' said James Caron, an interest-rate strategist at Merrill Lynch & Co. in New York. ``That will signal higher yields in Japan, which will make them at the margin less net buyers of U.S. Treasuries.''

Reading the Signs

In the past five years, every 3,500-point increase in the Nikkei has predicted a percentage point increase in the U.S. 10- year note's yield, Caron has found.

Treasury traders, for their part, view Japanese government bonds as the canary in their coal mine. In July 2003 and April 2004, yield surges in the Treasury market produced two of the worst months on record for investors. In both cases, and in others, the Japanese government bond market fell days before the Treasury market did.

Japanese government bonds ``have historically led most big downtrades'' in the Treasury market, said Glen Capelo, a trader at RBS Greenwich Capital in Greenwich, Connecticut, who has sold or traded Treasuries for 18 years.

Rising yields in Japan already have begun to curb the appetite of Japanese investors for Treasuries and other foreign bonds. Japan's holdings of Treasuries peaked in August 2004 at $699.4 billion. The total stood at $687.3 billion in September of this year, Treasury Department data released Nov. 16 showed. Japanese investors are the biggest foreign holders of U.S. government obligations.


Japanese investors have another reason to shun U.S. bonds -- the prospect that the dollar may lose value against the yen, making investments in Treasuries worth less in yen. The dollar has gained 16 percent gain against the Japanese currency this year, nearing a two-year high, leading some bondholders to speculate that the U.S. currency is due for a decline.

The cost of contracts protecting against a possible drop in the dollar wipes out the yield advantage that Treasuries have over Japanese government bonds, said Shinichi Takayama, who helps manage about $84 billion at Dai-ichi Mutual Life Insurance Co.

``It would be better to keep money at home rather than sending it abroad,'' said the Tokyo-based money manager. He said he plans to buy Japanese government bonds in the coming months.

False Dawn?

Rising yields in Japan don't necessarily spell bad times for the U.S. market, where the Fed has raised interest rates 12 times since June 2004 and may stop early next year, said Sudesh Mariappa, who oversees $68 billion of global bonds at Pacific Investment Management Co. in Newport Beach, California.

``At that stage we feel that the bond market in the U.S. has probably peaked in terms of rates,'' he said. Forty institutions that manage more than $1.3 trillion expect Treasuries to rise by June 30, according to a weekly survey by Ried, Thunberg & Co., a research unit of ICAP Plc, the world's largest inter-bank broker. Investors in the survey have been negative on U.S. debt for four years.

Japan's economic recovery also may be a false dawn, Putnam's Kohli said. Renewed weakness there would push global yields lower.

Japanese five-year notes last week had their biggest weekly gain in two years on investor bets that pressure from Prime Minister Junichiro Koizumi would prompt the central bank to keep rates low. Koizumi said Nov. 14 that it was ``too early'' for the bank to change its deflation-fighting policy. The yen fell against the dollar, approaching its highest in more than two years.

Kohli says the latest evidence still indicates rising rates.

``The data out of Japan and Europe, while not exploding, is a much different environment than it's been the last three years,'' said Kohli. ``If we get into a situation where their central banks are hiking, that's going to be the driver of higher global rates.''

To contact the reporter on this story:
Elizabeth Stanton in New York at

Last Updated: November 20, 2005 12:50 EST