Obama Bonds to Give Buyers Taste of Japan Lost Decade (Update2)
By Wes Goodman
Dec. 8 (Bloomberg) -- Japan’s biggest bond investors say Barack Obama has room to unleash a flood of Treasuries without driving up borrowing costs as he tackles the worst economy since World War II.
The U.S. is starting to look like Japan in the 1990s, when the Bank of Japan struggled to revive growth as the combination of deflation and recessions stranded the nation in the so-called Lost Decade. Yields on Treasuries are falling as the government sells a record amount of debt to prop up the American economy. Two-year note yields have fallen to 1 percent, compared with 0.57 percent for Japanese government bonds of similar maturity. The gap last week touched the narrowest since 1992.
“History repeats itself,” said
Hiroyuki Bando, chief manager for fixed income, equities and currencies in Tokyo at Mitsubishi UFJ Trust & Banking Corp., which manages the equivalent of $200 billion and invests on behalf of Japan’s biggest bank. “Based on our experience in Japan, the same thing will happen in the U.S. The U.S. has more room to borrow.”
Bando bought Treasuries, as did Mizuho Asset Management Co., which oversees $41.9 billion and bet all year that inflation in the U.S. will turn into deflation, buoying government debt. JPMorgan Asset Management Japan Ltd., part of the largest U.S. lender, is buying Treasuries, speculating the Federal Reserve will purchase the securities to keep yields down and spur the economy, just as the Bank of Japan did a decade ago.
Fed
holdings of Treasuries on behalf of foreign central banks and other institutions rose 12 percent since September, compared with a 7.7 percent increase last quarter.
Zero Rates
Yields on two-year U.S. notes have fallen for five straight weeks and are down from this year’s high of 3.11 percent in June. They may drop to 0.6 percent by mid-2009, JPMorgan Chase & Co. analysts led by
Terry Belton and
Srini Ramaswamy in New York said in a Nov. 28 report.
The level is “not unreasonable” since yields in Japan were between 0.1 percent and 0.8 percent for three months after the central bank began its zero-rate policy in 1999, the analysts wrote.
The Fed will cut its target overnight rate for loans between banks to zero by January from 1 percent now, the JPMorgan analysts said in their 2009 U.S. fixed-income outlook. London-based HSBC Holdings Plc and New York-based Citigroup Inc., which like JPMorgan are among the 17 primary dealers of U.S. government securities that trade with the Fed, also predict the rate will go to zero.
Payrolls Slashed
U.S. companies slashed payrolls last month by 533,000, the fastest pace in 34 years, and brought job losses so far this year to 1.91 million, the Labor Department said Dec. 5. The U.S. economy will likely contract by 2.2 percent on an annualized basis this quarter, the most since it shrank 3 percent in the October through December period of 1990, according to the median estimate of 78 strategists surveyed by Bloomberg.
“Investors are studying Japanese market history,” said
Shinji Kunibe, a Tokyo-based senior money manager at JPMorgan Asset, which oversees $847 billion globally. The company bought Treasuries in the last week of November, he said.
Japan’s government resorted to debt-financed public spending plans to jolt the economy in the 1990s, a move U.S. lawmakers are considering after Fed Chairman
Ben S. Bernanke and Treasury Secretary
Hank Paulson agreed to provide an unprecedented amount of cash to unlock frozen credit markets. The Treasury has set up a $700 billion bailout fund for the financial industry, while the amount of the assets held by the Fed more than doubled to $2.14 trillion last week from $889 billion in 2007.
Biggest Debt
In Japan, one result was the creation of the world’s biggest debt market, with
government bonds and bills totaling 787.2 trillion yen ($8.48 trillion), or more than 1.5 times
gross domestic product. The U.S. comes next at $5.3 trillion, based on records of 35 countries compiled by the Bank for International Settlements in Basel, Switzerland.
U.S.
federal debt rose to about 36 percent of GDP in September from 32 percent in 2001, as President
George W. Bush raised funds to spur the economy and pay for wars in Iraq and Afghanistan.
Gross issuance of Treasury coupon securities will rise to about $1.15 trillion in fiscal 2009 that started Oct. 1 from $724 billion the year before, according to Zurich-based Credit Suisse Group AG, another primary dealer. Morgan Stanley, based in New York, says it may reach $1.5 trillion.
Most Since 1995
Even as debt increased, two-year yields dropped 2.11 percentage points this year, touching a low of 0.77 percent on Dec. 5, according to BGCantor Market Data. The price of the 1.25 percent security due November 2010 rose 5/32, or $1.56 per $1,000 face amount, last week to 100 5/8. Ten-year yields tumbled 1.31 percentage points in 2008 to 2.71 percent.
For both maturities, the decline is the most since 1995, bringing yields to levels not seen since the Fed began keeping
daily records of the two-year note in 1976 and the 10-year security in 1962. Treasuries have returned 11.7 percent this year, including reinvested interest, according to Merrill Lynch & Co.’s U.S. Treasury Master Index.
Japan’s borrowing binge hasn’t stopped two-year yields from falling to 0.57 percent from this year’s high of 1.055 percent in June. Ten-year notes yield 1.36 percent, compared with 1.895 percent in June. Japanese government bonds returned 2.06 percent this year, based on Merrill indexes.
$700 Billion Plan
The danger is that demand for the relative safety of sovereign debt will ebb as government spending underpins the U.S. economy. The median estimate of 57 economists surveyed by Bloomberg is for 10-year note yields to end 2009 at 3.91 percent, which would represent a loss of about 5.7 percent.
The government arranged a $700 billion plan to rescue banks and an $800 billion program to provide credit for homebuyers and small businesses. Last week the Fed extended the term of three emergency-loan programs to April 30 from Jan. 30.
Congress is considering making loans to Detroit-based
General Motors Corp., Ford Motor Co. and Chrysler LLC. President-elect Obama said Dec. 5 that November’s job losses demonstrate the “urgent” need for the economic recovery plan he is proposing, which some lawmakers estimate may cost $700 billion. A day later Obama said on his weekly radio address that he’ll make the “single largest new investment” in roads, bridges and public buildings since the Eisenhower Administration.
‘Gobs of Money’
“The government’s going to be spending gobs of money,” said
Peter Fisher, New York-based co-head of fixed income at BlackRock Inc., which oversees $1.26 trillion of assets. “We’ll get through it because of how appropriately hyperactive fiscal and monetary policy are going to be.”
Demand for Treasuries may remain “substantial” as the global slowdown attracts so-called real-money investors such as pension funds, mutual funds and insurers, like it did in Japan, according to Morgan Stanley. These investors had $59.4 trillion under management at the start of 2008, about 10 times more than the amount of Treasuries outstanding, according to the firm.
“A severe global slowdown accompanied by a sharp decline in inflation could tilt the portfolios of these funds in favor of bonds,” London-based economists
Stephen Jen and
Spyros Andreopoulos wrote in a Dec. 4 note to clients.
Commercial banks may also buy more government debt, they said. Since 2000, Japanese banks increased their holdings of the nation’s bonds to 20 percent from 9 percent of total assets, Jen and Andreopoulos wrote. U.S. banks have about 10 percent of their assets in government securities, down from 20 percent in 2003.
‘Deflation Fear’
Like in Japan, a plunge in U.S. real estate threatens to lead to a general drop in prices in the economy, or deflation.
House prices in 20 U.S. cities fell 17.4 percent in September from a year earlier, the fastest decline on record, according to the S&P/Case-Shiller home-price index. The consumer price index fell 1 percent in October, the most since records began in 1947, according to the Labor Department.
The difference between rates on 10-year Treasury Inflation Protected Securities, or
TIPS, and notes, which reflects traders’ outlook for consumer prices over the life of the securities, narrowed to 42 basis points from this year’s high of 268 basis points in March.
“Deflation fear is alive and well,” said
Wan-Chong Kung, who helps oversee $76 billion in fixed income as a money manager at FAF Advisors Inc. in Minneapolis, the asset-management arm of U.S. Bancorp. “The constant parallels being drawn to the Depression era as well as to the Japanese experience leads to the feeling we’re looking at a pretty gloomy period for a long time.”
She’s been buying Treasuries when prices fall.
Mizuho, which predicted the rally in Treasuries in 2007 and 2008 as the U.S. housing market began to crumble, said government spending won’t keep prices and the economy from falling.
“Deflation, rather than supply, sent yields down in Japan,” said
Hiromasa Nakamura, a senior investor in Tokyo at the firm. “The same situation will occur in the U.S.”
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