Japanese government bonds edged higher on Monday and the yield curve flattened as Tokyo stocks struggled to capitalise on supportive factors, although the rise in debt prices was limited by profit taking following last week's sharp gains. The JGB market took higher-than-expected Japan GDP numbers released on Monday in stride, with economists saying growth will begin to slow as falling wages reduce the effectiveness of government stimulus.
Bond investors were also given another reminder that deflation is a threat to the economy, with the Nikkei business daily reporting on Monday that the Japanese government is set to announce the economy has fallen into deflation in a monthly report.
The benchmark 10-year yield dipped 0.5 basis point to 1.330 percent, matching a four-week low brushed on Friday. It rose to a five-month high of 1.485 percent early last week on concerns over Japan's worsening fiscal situation but declined sharply when such concerns eased, posting its biggest weekly fall since December.
"It is easy to focus on supply alone but also important to remember the other side of the coin, which is demand," said Akito Fukunaga, a fixed-income strategist at Credit Suisse. "Domestic investor demand for JGBs has persistently existed. It had been put on hold while the market was more volatile." Speculators unwound positions in futures and derivatives markets, which they had taken on bets that volatility would increase on fiscal concerns.
Investors bought back JGBs in turn as such trades were unwound, prompting a sharp market rebound last week. Japan's sovereign five-year credit default spread continued to tighten on Monday. The spread widened to around 77 basis points early last week, its highest since April, when fiscal concerns peaked but was quoted around 66 basis points on Monday.
Moody's Investors Service does not think the recent spread widening signals a "turning point" in the finance ability of Japanese government bonds, a Moody's official said on Monday. Thomas Byrne, senior vice president for the rating agency, said at a forum in Tokyo that signals sent out by the CDS market do not always reflect the credit fundamentals of the issuer.
In May, Moody's downgraded Japan's foreign currency rating to Aa2 from Aaa, but raised the domestic debt rating to Aa2 from Aa3. The outlook in both cases was stable. Japan said in October that it would increase debt issuance to the institutional market by 2.1 trillion yen for the fiscal year through March 2010 to offset poor demand for retail JGBs.
The government is expected to further increase issuance this fiscal year to make up for a likely tax revenue shortfall. Masaaki Kaizuka, a director of debt management for the MOF, told a business forum on Monday the ministry may lean more towards short-term JGB bond issuance rather than longer-term bonds as there was not much time left until the end of the fiscal year.
December 10-year JGB futures were little changed after spending the day in a tight range, inching down 0.02 point to 138.86. The two-year yield was flat at 0.245 percent. The five-year yield was unchanged at 0.615 percent. The 20-year yield declined 1.5 basis points to 2.080 percent and the 30-year yield fell 1 basis point to 2.225 percent.
The two-year/10-year yield spread tightened by half a basis point to 108.5 basis points, pulling further away from a 3-1/2 year high of 121 basis points reached last week. The Nikkei stock average eked out a 0.2 percent gain despite the stronger-than-expected third quarter Japan gross domestic product numbers. Japan's economy grew 1.2 percent in the July-September quarter as capital spending picked up, above consensus market forecast for a 0.7 percent gain.