WORLD BONDS -Japan still holds few attractions
09:17 a.m. Sep 22, 1998 Eastern
By Paul Bolding
LONDON, Sept 22 (Reuters) - Record low yields on Japan government bonds (JGBs) mean they hold little attraction for foreign investors but nothing seems able to deter domestic flows.
A rating downgrade for Japan on Monday and continuing delays to much needed banking reform only reinforce the dim view held of Japan from outside.
''From a foreign currency perspective, I view Japanese bonds as offering little potential,'' said James McKay, chief European economist at Commonwealth Bank of Australia in London.
He said the change in the benchmark JGB on Tuesday to the 203rd from the long-running 182nd could lead to some switching but otherwise would have little effect, he said.
Japanese investors keen to hold a risk-free asset were seen continuing to hold JGBs but McKay noted they had been increasingly looking abroad - buying U.S. Treasuries and German Bunds.
''I suspect that will continue with the euro taking off - that will be a strong currency as the European Central Bank tries to build credibility,'' said McKay.
Gianpaolo Mosconi, bond analyst at Sanwa International, saw the yield on the 203rd bond possibly falling as low as 0.75 percent but not rising above one percent this year.
The yield was 0.90 percent compared with 0.89 at Monday's close.
''For foreign investors I would not recommend buying JGBs with such low yields. You would get much better returns in other markets,'' Mosconi said.
Mosconi said the spread to Treasuries, now around minus 383 basis points, had lately narrowed by around 20 bp, reflecting diverging monetary policy between the two.
''In the U.S. the next move will be a rate cut while in Japan they cannot do anything,'' he said.
Other analysts say that for fund managers who have to hold some Japanese assets, JGBs were not all bad since the yield curve was at least positive, in contrast to the inverted U.S. curve. There could also be currency gains.
Mosconi said he saw dollar/yen rising for the time being to 137.50 from around 135 now, but an investor might take a view that the yen would strengthen to around 133.
''Foreign investors could then take profits on that basis but I really would not recommend they invest much in JGBs,'' he said.
Monday's downgrade of Japan by rating agency Fitch IBCA had caused JGBs to weaken in London but more important would be the view of the two leading agencies, analysts said.
Standard and Poor's had recently reaffirmed Japan at AAA and much would now hang on Moody's.
A cut by Moody's would have more effect. ''Initially I would expect JGBs to fall. The long end of the curve would see most of the losses,'' said Mosconi.
But he said domestic investors would still view this as a buying opportunity.
Seemingly interminable wrangling over reforms to the troubled banking system has not helped the view of Japan from abroad either.
But Mosconi said he expected agreement before the current session of parliament ends in the first week in October.
''The longer they procrastinate the worse it is for the equity market and it supports bonds because investors want to keep their money in safe haven markets,'' he said.
It also helps bonds by delaying increased supply that could be needed to fund a bank rescue scheme.
''When final agreement is announced, equities will rise on that and the long end of the JGB curve will see yields rising and the yield curve will steepen,'' said Mosconi.
Commonwealth Bank's McKay expected substantial future JGB issuance to fund budgetary problems including pensions for a rapidly ageing population.
''What Japan should be doing is printing money, reflating the economy - trying to prompt consumers to spend by encouraging a feeling of inflation starting to rise and getting Japan out of the liquidity trap where it is at the moment,'' he said.
((International Bonds Desk +44 171 542 6701, Fax +44 171 542
5285, uk.governmentbonds.news+reuters.com))
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