Defflation Predicted for U.S. by Japanese Bond Trader Who Ought To Know

“The U.S. economy has faced a double whammy: the recession and credit contraction,” said Akira Takei, head of non-yen denominated bonds at Mizuho Asset in Tokyo, a unit of Japan’s second-largest bank. “The U.S. will face a triple whammy with deflation. That’s good for the Treasury market.”

Japan Tops China Buying Treasuries as Lost Decade Survivors Buy
Share Business ExchangeTwitterFacebook| Email | Print | A A A

By Wes Goodman and Cordell Eddings

http://www.bloomberg.com/apps/news?pid=20601087&sid=am7sso5EFo8c&pos=4

Nov. 9 (Bloomberg) -- Japanese investors who lived through a decade of deflation and recessions say U.S. Treasuries are a bargain even with yields at about the lowest levels since at least the 1960s.

Japan bought a net $105 billion of U.S. government debt through August, exceeding China as the biggest foreign buyer and boosting its holdings to $731 billion, or more than 10 percent of the total market, Treasury Department data show. The 17 percent increase is the most since a 25 percent surge in 2004.

Mizuho Asset Management Co. and Mitsubishi UFJ Asset Management Co. are among the investors buying U.S. bonds because they see similarities between America’s response to the recession and their government’s efforts during the so-called lost decade of the 1990s. An index of Japanese debt securities compiled by Bank of America Corp.’s Merrill Lynch unit returned 90 percent in the 1990s, while the Nikkei 225 Stock Average fell as much as 67 percent between January 1990 and October 1998.

“The U.S. economy has faced a double whammy: the recession and credit contraction,” said Akira Takei, head of non-yen denominated bonds at Mizuho Asset in Tokyo, a unit of Japan’s second-largest bank. “The U.S. will face a triple whammy with deflation. That’s good for the Treasury market.”

The 3.625 percent benchmark U.S. 10-year note due in August 2019 closed last week at 101 1/32 to yield 3.5 percent. The yield has averaged 3.19 percent in 2009, the lowest since the Federal Reserve began providing daily data on the securities in 1962 and down from 3.64 percent for all of 2008.

Takaei’s Forecast...

Takei, who helps oversee the equivalent of $21 billion, bought Treasuries in July and predicts 10-year yields will decline to 2.75 percent by year-end. An investor who purchased $10 million of the notes would earn about $715,000 if yields dropped to Takei’s forecast, according to data compiled by Bloomberg.

Government securities have lost 2.8 percent since December, when 10-year yields fell to 2.04 percent, according to the Merrill Lynch U.S. Treasury Master Index data. Treasuries are on a pace to post their first annual losses since 1999 as the recovery in the global economy following the worst financial crisis since the Great Depression reduces the appeal of the debt as a haven.

Similar to Japan’s response to its real estate collapse in the 1990s, the U.S. is flooding the economy with cash only to see financial institutions sock the money away in bonds instead of making loans.

Inflation Protection

The Fed and the U.S. government have spent, lent or guaranteed $11.6 trillion to spur the world’s biggest economy from recession and curb a decline in asset prices. The Standard & Poor’s 500 index has gained 58 percent to 1,069.30 from its low this year of 676.52 on March 9, though it’s below the peak of 1,576.09 reached in October 2007.

“Japanese investors have been skewed to expecting deflation because of their own experience, but the more pressing concern over the intermediate term is inflation,” said Michael Pond, an interest-rate strategist in New York at Barclays Plc, one of 18 primary dealers that trade with the Fed.

Pond favors Treasury Inflation Protection Securities, or TIPS, and said Asian investors, including the Japanese, have been buying the bonds on concern the dollar will continue to decline and inflation will accelerate. Barclays expects consumer prices to rise 1.9 percent in 2010, after a decline of 0.4 percent this year, data compiled by Bloomberg show.

During the 1990s, Japan’s economy grew at an average rate of about 1 percent a year as asset prices tumbled. It hasn’t fared much better this decade, with gross domestic product expanding 0.2 percent on average and consumer prices falling 0.2 percent.

Consumer Prices

The threat of deflation, a general drop in prices that enhances the value of a bond’s fixed payments, makes Treasuries attractive to Japanese investors even with bond yields rising from last year’s lows. U.S. consumer costs fell 1.3 percent in September from a year earlier, according to the Labor Department. They dropped at a 2.1 percent annual rate in July, the most since Harry S. Truman was president in 1950.

Ten-year notes pay a real yield, or what investors get after accounting for the cost of living, of 4.91 percent, above the five-year average of 1.42 percent.

“The recovery is very weak and the U.S. is running the risk of deflation,” said Hideo Shimomura, who helps oversee the equivalent of about $55.4 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset, part of Japan’s largest bank.

CONTINUED

 

CONTINUED

Surpassing China

Mitsubishi UFJ bought Treasuries in October, said Shimomura, who expects 10-year yields will fall to 3 percent by year-end.

Japan’s purchases exceed those of China, which has boosted its holdings 9.6 percent, or $69.7 billion, to $797.1 billion, Treasury data show. Japan’s buying spree started in May 2008, after its U.S. debt dropped to a four-year low of $575.3 billion.

The Fed’s pledge last week to keep interest rates near zero for an “extended period,” the absence of a recovery in U.S. real estate and hoarding of cash by banks has Japanese investors such as Shimomura saying the parallels are too close to what happened in Japan.

The S&P/Case-Shiller home-price index for 20 U.S. cities fell 11.3 percent in August from a year earlier. Bank holdings of government securities and debt of mortgage companies Fannie Mae in Washington and McLean, Virginia-based Freddie Mac increased to $1.39 trillion in the week ended Oct. 21 from $1.26 billion a year earlier. Commercial and industrial loans fell 17 percent from an all-time high a year ago to $1.37 trillion as of Oct. 21, a record decline.

‘Yields to Fall’

Banks in Japan such as Mitsubishi UFJ Financial Group Inc. and Mizuho Financial Group Inc., the two largest by assets, own 116.9 trillion yen of government securities, the most since Bank of Japan figures started in 1993.

“Demand for Treasuries is very good because of the idle money in the banking system,” said Satoshi Okumoto, a general manager at Fukoku Mutual Life Insurance Co. in Tokyo, which has the equivalent of $60 billion in assets. “In 2010, there will be a second dip in the economy. There will still be room for yields to fall.”

Fukoku plans to add to its holdings if 10-year yields rise to 4 percent, he said.

Paul McCulley, a partner at Pacific Investment Management Co., which runs the world’s biggest bond fund, said Oct. 29 that investors should sell riskier assets such as stocks and high- yield corporate debt because the U.S. recession “might not even be over.” Those types of assets carry “lofty valuations,” McCulley said a report posted on Pimco’s Web site.

New Normal

Officials at Newport Beach, California-based Pimco say there is a “new normal” in the global economy that includes heightened government regulation, lower consumption, slower growth and a shrinking global role for the U.S.

Pimco began adding longer-maturity Treasuries to the $192 billion Total Return Fund during the third quarter, according to the firm’s monthly reports.

Prospects for economic growth combined with the record amount of debt the U.S. is selling are enough to prevent Daiwa Asset Management Co., part of Japan’s second-largest brokerage, from buying. After contracting 2.5 percent in 2009, the U.S. economy will expand 2.4 percent next year and 2.85 percent in 2011, separate surveys of economists by Bloomberg News show.

Budget Deficit

“The economy will be picking up throughout the next year,” said Tsutomu Komiya, a Daiwa investment manager in Tokyo who helps oversee the equivalent of $77 billion. “The huge issuance will make Treasury yields go higher.”

The U.S. budget deficit widened to a record $1.42 trillion in the 12 months to Sept. 30 as the administration increased spending to revive the economy. The Treasury is scheduled to sell $40 billion of three-year notes today, $25 billion of 10- year debt tomorrow and $16 billion of 30-year bonds on Nov. 12. The amounts are all-time highs for each maturity.

“The medium term risk toward inflation is being caused by potential policy missteps by policy makers in regards to monetary and fiscal policy and the weakening dollar,” Pond said.

Barclays forecast that 10-year yields will rise to 4.60 percent by the end of next year. Intercontinental Exchange Inc.’s U.S. Dollar Index, which tracks the currency’s performance against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, fell 15 percent to 75.819 last week from its high this year of 89.624 on March 4.

Borrowing Estimate

Record U.S. debt sales may be peaking. The Treasury Department cut its estimate for borrowing in the current quarter by 43 percent on Nov. 2, largely because of reductions in a program for helping the Fed manage its balance sheet. Borrowing will total a net $276 billion from October through December, compared with a previous estimate of $486 billion.

While the difference between rates on 10-year notes and TIPS, which reflects the outlook among traders for consumer prices, widened to 2.18 percentage points from almost zero at the end of 2008, it’s equal to the five-year average.

In Japan, the so-called breakeven rate is negative 1.1 percent, when measured using nine-year bonds, the lowest among all government inflation-index debt.

“Any economics textbook would tell you that the massive stimulus from the central government will eventually cause inflation, but the Japanese know it doesn’t have to turn out that way,” said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey and a former official at the Monetary Authority of Singapore, that nation’s central bank.

U.S. Unemployment

Rising unemployment in the U.S. means Treasuries are still worth buying, said Shuhei Mochizuki, assistant manager in Tokyo at the foreign-bond section at Sumitomo Life Insurance Co., which oversees the equivalent of $221 billion. Ten-year yields will be 3.25 percent by year-end, he said.

The unemployment rate reached a 26-year high of 10.2 percent in October as payrolls fell by 190,000, the Labor Department said Nov. 6.

“Employment conditions are worsening,” Mochizuki, assistant manager in Tokyo at the foreign-bond section at Japan’s fourth-largest life insurer. “Yields will fall.”

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net; Cordell Eddings in New York at o ceddings@bloomberg.net.
Last Updated: November 8, 2009 13:00 EST

 

There will be no deflation.
There will be an inflation ( printing too much of $$$ )

 

wrong my boy. japan printed yen to the moon and has had zero rates for 15 years and no inflation. inflation can't happen no matter what the fed prints unless the banks lend and people spend. i guess in a last act of desperation the fed can mail 100k checks to all households and demand they spend it but then the $ would be zero and a gallon of milk would be $100. its checkmate and game over. we're seeing the last acts of desperation now. the us gov't refused to take the short term pain and now we'll all suffer 5 times as long .

 

the us gov't refused to take the short term pain and now we'll all suffer 5 times as long .
------------------------------------------------------------------------------

I have to agree, the majority of the people will feel the pain for a very long time.

Inflation will show up......via Energy Prices. Oil is still near 80 with very little demand at the moment. Inflated prices in Imported goods, Energy, Food. Deflation in Staples such as Clothing, Rent, Consumer goods made in the USA.

Dollar is near its bottom but I do not expect any bounce that will be worth much. Retail Numbers for this year will be the worst ever reported when adjust after Xmas season.

We are going to have a combination of Inflation in some areas and Deflation in others.

However, Plenty of ways to make money right now.

 

It's the government that has to pay and it is the government that will pay. Either people will be pretty much be enslaved by them through taxes or people will get so fed up of the government they'll just get rid of them.

It's a shame really the difference between us and the folks in medieval times is that we've been tricked so much into complacency that the very few who actually have the balls to fight against our governments are either labelled, terrorists, criminals or conspiracy theorists. If a fucking lord was pissing off the peasants too much by getting them all in debt and planning on raising taxes as high as they could get with the way things are going they'd just march up to the castle and lob the morons head off.

I don't condone violence in any way but if a government itself isn't peaceful and doesn't obey the law then what law can you fucking rely on to put them in their place? Police and the military simply follow the orders of the government so there's no fucking help there even though they are actually supposed to be there to protect the people.