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To: goldsnow who wrote (27871)	2/8/1999 5:22:00 AM
From: Alex	Read Replies (1) \| Respond to of 116764

Japanese Government Bond Yields Headed to 5 Percent? A steep yield curve would benefit the banks Could 10-year Japanese government bond yields be heading towards 5 per cent? Six months ago the idea would have seemed outrageous, given that the country was breaking historical records with yields below 0.7 per cent. But as the state of the Japanese economy deteriorates and the government threatens to flood the market with about ¥40,000bn of new bonds, the thought of Japanese bond prices falling even lower and yields rising higher is no longer inconceivable. Last week the yields on 10-year JGB touched a recent high of 2.44 per cent and some analysts are predicting even more dramatic upswings. Takeshi Fujimaki, branch manager at J.P. Morgan, says: "I think bond yields could go to 3 per cent in March and even 5 per cent by the end of the year." This view remains an extreme one: the consensus in the market is that yields will probably remain under 3 per cent this year. But Mr Fujimaki's forecast reflects broader anxiety. According to a report by Barclays Capital, entitled "Japan: Apocalypse Now", the rising level of debt and debt/GDP ratio, means Japan faces an unstable debt situation which could have an adverse impact on the country's credit rating. Japan's ratio of government debt to gross domestic product has increased from 61.4 per cent in 1990 to almost 100 per cent last year, and according to Barclays' research Japan is fast approaching countries such as Belgium and Italy, whose debt/GDP ratio peaked at 135 per cent. Yet some economists argue the yields are unlikely to rise much further, provided short-term interest rates remain unchanged. "The extent to which yields could rise depends on how steep the yield curve will become," says David Knott at Deutsche Bank. "Historically, another 50 basis points on 10-year bonds would bring the yield curve to a historically steep level." He argues that steepening of a yield curve can help banks to recapitalise. This is because banks are able to borrow short-term money at low interest rates and re-invest in longer-term securities at higher rates. "Typically, when a central bank wishes to inject profits into the banking system, it steepens the yield curve," says Mr Knott. A steeper curve was a factor helping US banks to boost profits in the early 1990s - allowing them to recapitalise. Kiichi Miyazawa, finance minister, appears very relaxed about bond yields, sparking rumours that the government "secretly" wants to drive yields higher to help banks. Such conspiracy theories probably give the government too much planning credit: in practice, there is precious little sense of policy co-ordination at the moment. And since Japanese companies tend to rely more on short-term funding than their US counterparts, a steeper yield curve would have less impact. Hiroshi Toda, global head of debt markets at Nomura, blames the steeper yield curve not on government policy but on a structural "mismatch" between public institutions which want to increase long-term borrowing and private investors, such as Japanese banks, that want to focus on short-term investments. "I think that the market is in a transitional period . . . We will see a steepening of the yield curve as investors try to find the new equilibrium," he says. Yet what has startled many observers is the speed of the JGB swings and their apparent lack of relation to economic fundamentals. Consequently, opinions on where the JGB market may be heading next are now based as much on socio-political as on economic analysis. As Masuhisa Kobayashi, analyst at Merrill Lynch, says: "Japan is now backed into a corner, where textbook economics no longer makes sense." What has dented investor confidence, however, is political uncertainty. It is still unclear, for example, just what the real level of JGB supply next year will be. The government claims that net new JGB issues will be only ¥31,000bn. But this does not include additional spending measures, or the large quantities of local government debt that some municipalities are threatening to issue. Nor, most importantly, does it include any bonds that might be issued to fund the ¥60,000bn banking reform package. And suggestions by politicians that Japan should raise funds to buy land or stocks have further unnerved the markets. It is also unclear how fast the government wishes to impose reform on its traditional system of public finance. Public institutions such as the Trust Fund Bureau have traditionally absorbed about half the JGB market. If the government presses ahead with its apparent pledges to change this system, it could deliver painful new blows to the market. Meanwhile, even the government's short-term policy goals appear contradictory. Some politicians have reacted to the recent surge in bond yields with horror, and are calling on the Bank of Japan to start purchasing bonds directly from the government, in effect "monetising" its debt. Masaru Hayami, the bank governor, has dismissed these calls. Yet many economists believe inflation could be the only way to kick-start Japan's flagging economy. The Financial Times, Feb. 8, 1999