Japanese government bonds gained on Monday, with the five-year yield dropping to a four-year low, after the yen's broad surge sent Tokyo shares sharply lower. The yen's rise also fanned deflation concerns as a stronger Japanese currency reduces the cost of imported goods, which in turn can push down consumer prices.
The yield curve flattened as super-long yields fell the most, with their fall exacerbated by a drop in yen interest rate swap rates triggered by those trying to hedge their exposure to currency-linked structured products in the wake of the yen's recent surge, market players said.
"The market environment is favourable. There are redemptions this month, the Bank of Japan will likely keep interest rates low and recent economic figures failed to give us confidence in the Japanese economy," said Satoshi Yamada, general manager at Okasan Asset Management.
About 10 trillion yen ($110 billion) of JGBs will mature later in September, much of which is expected to be re-invested in safe-haven government debt. The yield curve flattened despite an upcoming auction of 1.1 trillion yen of 20-year JGBs on Tuesday as concerns that the Democratic Party of Japan - poised to assume power from the Liberal Democratic Party later in the week following a landslide election win last month - will rely heavily on extra debt issuance have somewhat receded, analysts said.
Hirohisa Fujii, tipped by media to be appointed as the finance minister in the new cabinet, is considered a fiscal conservative by some. Some participants were concerned the super-longs may have become too expensive ahead of the 20-year sale.
"It is hard to imagine domestic life insurers getting enthusiastic about buying the 20-years at such low yields," said Takafumi Yamawaki, a senior fixed-income strategist at BNP Paribas Securities. "The market may have to count on other investors to carry the auction through, like pension funds and players eyeing asset swaps, but it can also draw confidence as it has handled extra supply well."
The 30-year yield fell 1.5 basis points to 2.175 percent and the 20-year yield declined 2 basis points to 2.025 percent, a two-month low. The benchmark 10-year yield dropped 1 basis point to 1.290 percent. The five-year yield fell 1.5 basis points to 0.560 percent, its lowest since September 2005. The two-year yield was unchanged at 0.205 percent.
December 10-year JGB futures rose 0.11 point to 139.26. The five-year/20-year yield spread tightened by a basis point to 146.5 basis points. Longer-dated yen interest rate swap rates fell on Monday due to firm receiving. Derivatives desks are often forced to hedge against exposure to currency-linked structured instruments by receiving in longer-dated interest rate swaps as these instruments turn into long-term yen securities when cross/yen falls and triggers embedded options barriers.
The bid rate on the 20-year swap rate dropped roughly 2 basis points to 198.5 basis points. The dollar touched a seven-month low of 90.18 yen on trading platform EBS on Monday. The Nikkei share average lost 2.3 percent as blue chip exporters sagged on the appreciating yen.