Japanese Bonds Drop for Second Week on Improving U.S. Economy

By Issei Morita

June 2 (Bloomberg) -- Japan's government bonds fell for a second week, pushing yields to the highest in seven months, on speculation export demand from the U.S. will be supported as the economy recovers from a slowdown.

Japanese bonds due in 10 years or more last month handed investors the biggest loss in almost a year, according to a Merrill Lynch & Co. index. Benchmark 10-year bonds declined as reports this week showed U.S. consumer confidence and business activity increased, adding to expectations the economy will rebound from the slowest quarterly growth in more than four years.

``Japan's bond yields finally started to rise and investors are reluctant now to buy,'' said Satoshi Kon, who helps oversee the equivalent of about $19 billion in Japanese debt at the Pension Fund Association, which has more than 1,600 corporate funds as members. ``There is a widespread expectation that the U.S. economy is now rebounding.''

Benchmark 10-year bond yields rose 5 basis points this week to 1.77 percent in Tokyo, according to Japan Bond Trading Co., the nation's largest interdealer debt broker. The yield on the 1.7 percent bond due March 2017 climbed as high as 1.775 percent, the most since Oct. 26.

The yield on the five-year note touched 1.375 percent, the highest since August. A basis point is 0.01 percentage point.

Worst Return

Japanese bonds maturing in 10 years or longer handed investors a loss of 0.9 percent in May, the worst return since June last year, when they incurred a loss of 1.5 percent, according to the Merrill Lynch index.

Ten-year yields rose 13 basis points last month, less than half the advance of similar-maturity U.S. Treasury yields. The spread between 10-year Japanese and U.S. yields was 3.15 percentage points yesterday, compared with the average of 3.04 points in the past year.

``Yields overseas are high on economic optimism, and Japan's yields have room to catch up,'' said Xinyi Lu, chief strategist of the international treasury division at Mizuho Corporate Bank Ltd. in Tokyo.

Large Redemption

The decline in bonds was limited by speculation buying in the secondary market will increase this month as more debt will mature than the Ministry of Finance is scheduled to sell.

``This month we have a large redemption coming,'' said Maki Shimizu, a bond strategist at UBS Securities Japan Ltd. in Tokyo. The extra demand for bonds may push the 10-year yield down to 1.7 percent by the end of next week, she said.

Redemption of maturing bonds and purchases by the central bank and Ministry of Finance will remove 3.2 trillion yen ($26.2 billion) of government debt from the market this month, according to calculations by Mitsubishi UFJ Securities Co.

Japan's bonds also fell this week on concern the central bank will raise borrowing costs as early as next quarter, said Akio Kato, senior portfolio manager at Kokusai Asset Management Co. in Tokyo. Government reports this week showed the jobless rate dropped to a nine-year low and household spending rose for a fourth month.

Bank of Japan Governor Toshihiko Fukui said last month that even with prices falling the risk of excessive investment might be a reason to raise interest rates. The bank key overnight lending rate is 0.5 percent.

Fukui's recent comments have ``reminded us that the BOJ's willingness to increase rates is very firm,'' Kokusai's Kato said. The bank will increase rates as early as August, he said.

The gap in yields between two- and 20-year bonds narrowed to 1.15 percentage points on May 30, the least since July 2003, according to data compiled by Bloomberg using compound yields.

Bond futures for June delivery declined 0.57 this week to 132.86 on the Tokyo Stock Exchange.

To contact the reporter on this story: Issei Morita in Tokyo at imorita@bloomberg.net .
Last Updated: June 1, 2007 18:51 EDT