Financial laws no longer operative under unprecedented stress, where light fail to emerge from a cosmic debt black hole, but is failing to even escape my jar of peanut butter ... free money rejected
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Swap-rates conundrum with yields under JGBs
markets.scmp.com
Monday, July 16, 2001
REUTERS in Tokyo
It takes a lot to baffle Tokyo traders accustomed to the bizarre notion of free money, but the weird goings-on in Japan's yen swap market have got many people scratching their heads.
Last week, in an unprecedented development, interest rates in the swap market dropped below the yields on Japanese Government bonds. And that is not supposed to happen.
On the face of it, the drop suggested financial markets viewed the government, with its unlimited powers to raise taxes, as a greater credit risk than commercial banks.
"This is a bit abnormal. Things will go back to normal in the long run, but I don't know how long it will take," a European bank trader said.
Late on Friday the mid-range of 10-year swap rates was 1.3175 per cent, below the benchmark 10-year JGB yield of 1.32 per cent. As recently as April, 10-year yen swap rates were about 10 basis points above JGBs.
It is a stark contrast with swap rates in other currencies, such as 88 basis points for 10-year United States' Treasuries.
"Swap rates have fallen because of advantages in the accounting system," said Nikko Salomon Smith Barney vice-president Akihiko Inoue.
Japan is introducing full-scale mark to market accounting this financial year but swap deals can be exempt from mark to market during the 12-month period.
As a result, Japanese banks have been trading aggressively in the swaps market, receiving fixed swap rates in exchange for floating six-month London interbank offered rates (Libor), which is based on the average of rates from seven Japanese and nine foreign banks.
Such swap deals earn banks profits because 10-year fixed rates, around 1.3175 per cent, are much higher now than six-month Libor rates, which are 0.09 per cent.
Dealers also said there was speculation the government might extend the mark to market exemption for a year to help banks.
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