Despair and dismay in Japanese bonds

IFR 2131 30 April to 6 May 2016
5 min read
Jonathan Rogers

DESPAIR REIGNS IN the yen bond market. That was the word used by a market veteran whom I recently visited in Tokyo – and it’s easy to see why.

Just one Samurai bond has crept over the line so far this year (for Westpac in early January) and volumes are sharply down in the domestic market. Buyers are on strike against the minuscule coupons on offer, and about 90% of all Japanese Government Bond issuance now gets booked by the Bank of Japan.

My contact went on to describe the “Abenomics” programme of Japan’s prime minister Shinzo Abe which has been in place for over three years as “sputtering along”.

That seems a fair assessment, judging by the actions last Thursday of the Bank of Japan, which kept in place its negative interest rate policy and vowed to increase base money by ¥80trn (US$730bn) per annum via its asset purchase programme. That has tripled the BoJ’s balance sheet in barely three years.

Still, in this case, sputtering begins to resemble failure. Last week’s release of dire consumer price data for March, which showed prices falling at their fastest pace in three years, by 0.3%, taken together with a likely decline for Japan’s GDP in the final quarter of last year would suggest so.

The project to boost inflation by weakening the yen seemed to be working when Abenomics was first initiated. But the yen has surged of late, and the decision by the BoJ last Thursday not to ramp up stimulus further pushed it up by more than 2% versus the US dollar. None of this is following the script.

But you wouldn’t guess anything was wrong with the Japanese economy from wandering around Tokyo’s Shinjuku, the metropolis’s skyscraper hub. It remains as exhilarating and frenetic as it was when I first set foot in the place almost 30 years ago as a wet-behind-the-ears trainee on the Nomura graduate programme.

The difference perhaps is a glaring surfeit of senior citizens. Excessive smoking and alcohol indulgence in the myriad diminutive “resutorans” is as rampant as ever, but something must be working for the aging Mr and Mrs Watanabe. Perhaps it’s the sashimi.

BUT TO RETURN to the yen bond market. Its problem right now is negative interest rates, even if quite a few traders have made decent money by trading bonds like equity for capital gains as rates have pushed into negative yield territory.

Negative rates prevail on JGBs out to 12 years, while interbank swaps are negative out to six. Meanwhile the dollar/yen basis swap has gone deeply negative to the tune of 90bp at five years, having been roughly around minus 40bp for the most of the past three years before January.

Put plainly, that means if you pay yen Libor flat for five years, you’re swapping back at US dollar Libor plus 90bp. No one wants to do that, which helps explain the dearth of Samurai issuance. The heyday of the big US money-centre banks issuing gargantuan multi-tranche Samurais has gone and it’s hard to see what could bring it back in the prevailing rate environment.

If there is a tiny ray of sunshine, it is in the new approach among investors, who are to some extent accepting the inevitable and now looking at absolute coupon rates.

Forget spreads; they are now meaningless. So they are targeting, on decent quality credits, 0.2% at five years, 0.3% at seven years and 0.4% at 10 years. They might get their wish if there are potential Samurai issuers out there who are not looking to swap back to dollars.

Some sovereigns are in the process of roadshowing potential Samurais in Tokyo and French banks are circling the market. The latter might make sense, given that the euro/yen basis is more benign than dollar/yen.

THE BRIGHT SPOT amid the gloom has been the private placement market, where deals have been printing, notably for Singapore’s DBS, which recently priced a 10-year Tier 2, while Qatar National Bank priced a senior 10-year. But these each came in at just 20bn. That kind of deal flow is hardly enough to keep the booze flowing in Roppongi for your old-school DCM professional.

One thing has changed for the better in the Samurai market – at least according to my veteran contact. Whereas it was always almost religiously a Double A or above market, Single A and Triple B issuers are now gaining a foothold. That represents progress on a bit more credit curve flexibility but don’t expect a high-yield market to emerge just yet in yen. They’re just not ready for it.

Change comes slowly in a country with such a taste for tradition and a perceived sense of the right way of doing things. In trying to rush through change, Mr Abe is already rocking the boat. The question now is just how choppy the unchartered waters of Japan’s rate experiment will become. He will be hoping that despair does not transform into crisis.

Jonathan Rogers_ifraweb