Yield on Japanese Government Bonds Slides to 4-Year Low

Japan already has the world’s lowest government bond yields, but they’re getting even lower. It’s a worrisome sign that investors believe the nation’s deflation woes will deepen in 2003, experts say.

The annualized yield on the benchmark 10-year Japanese government bond fell to 0.95% on Tuesday, the lowest since the yield briefly plunged to 0.8% in the autumn of 1998 when the near-failure of a huge U.S. investment fund caused a temporary panic in world markets.

By contrast, 10-year U.S. Treasury notes yield about 3.94%.

Japanese investors were willing to accept ever-lower yields on government bonds in the 1990s as the economy faltered repeatedly and the stock market continued to slide.

What’s more, because Japan is suffering from deflation rather than inflation, the true return on bonds is higher than the nominal yield. That’s because as purchasing power rises, the promise of interest to be paid in the future is worth more than money now.

Japanese consumer prices, other than for fresh food, have been in a virtually constant downtrend since April 1998.

Japanese government bond yields had been rising in the first part of the year, reaching a high of 1.5%, as some investors bet that the nation might finally be on the verge of reversing its economic decline.

But yields have plunged anew since late summer and fell below 1% early in November.

In recent weeks, bonds have become more attractive on expectations that the U.S. dollar will continue to weaken against the yen, analysts said.

The dollar’s value has been sliding against the euro, the British pound and other key currencies on fears that a U.S.-Iraq military conflict will drive foreign investors to sell U.S. holdings.

The dollar has weakened modestly against the yen, falling from 125 yen on Dec. 5 to 120.33 this week.

A stronger yen would reduce the prices of goods that Japan imports. That would exacerbate deflationary pressures, analysts said, driving more investors into government bonds, despite the low yields.

“A stronger yen is positive for bonds,” said Yoshiaki Murakawa, who manages about $2.5 billion at SG Yamaichi Asset Management. “The dollar has greater chances of falling against the yen in coming weeks on concern the U.S. may attack Iraq as early as late January.”

Investors’ year-end settling of accounts also has had a bullish effect on Japanese bonds: Investors who aim to hold the safest securities ahead of the long New Year’s holidays have been loading up on government bonds.

Financial markets in Japan will be closed from Dec. 31 to Jan. 5.

But some analysts say the bond rally could be short-lived if the government shows new resolve to address deflation.

Prime Minister Junichiro Koizumi has said he wants the next Bank of Japan governor to focus on fighting deflation. The current governor, Masaru Hayami, will retire in March.

“The government is increasing pressure on the central bank to boost consumer prices,” said Hiroyuki Kubota, a fixed-income analyst at RP Tech Inc. “That may make it tougher to justify pushing bond yields down from here.”