When a country has been trying unsuccessfully to beat deflation for more than a decade, issuing an inflation-linked bond may seem to be a rather bold idea. But ever since Japanese prime minister Shinzo Abe and central bank governor Haruhiko Kuroda took control to combat an overly strong yen and spur growth, issuing linkers could be a good idea, say debt capital market (DCM) bankers.
“They have been waiting for the timing to restart this type of financing for the past several years,” said Reiko Hayashi, head of Japan DCM at Bank of America-Merrill Lynch to Asiamoney PLUS in a telephone interview on June 11. “I think the investors would be interested. In the international market, there are a lot of inflation-linked bonds, so there is no reason why the MoF [Ministry of Finance] would not raise this kind of product. This is in line with market demand.”
Japan’s MoF is finalising a plan to issue up to ¥300 billion (US$3 billion) of inflation-linked bonds – also known as JGBi – in October and another of a similar volume in January, according to sources cited on Reuters. The government has said it plans to sell ¥600 billion in linkers in the fiscal year ending March 2014 but has not announced the details of the timing.
The nation’s rising inflationary pressures support the issuance of these instruments, note economists.
“One can certainly see a strong case for investors to be interested in inflation-linked bonds, although it has not been a good investment vehicle in Japan given that inflation has run pretty consistently at moderate negative rates,” said Klaus Baader, chief Asia Pacific economist at Société Générale (SocGen) to Asiamoney PLUS. “That is something that is going to change quite drastically and in fact, if you look at the more recent data, it does appear that Japan has escaped deflation.”
The core consumer price index (CPI), which strips out volatile fresh-food prices, fell 0.4% in April from a year earlier, but it rose 0.3% compared to March. In similar good news for Japanese policymakers, core CPI for the Tokyo metropolitan area – seen as a leading indicator for prices in the nation as a whole – rose 0.2% in May from April. It was up 0.1% from a year earlier.
SocGen expects inflation nationwide to be running at 0.5% to 0.6% by year-end. Still, the tiny gains remained well below the central bank’s 2% inflation target, which it hopes to achieve over the coming two years.
The yen has to continue to stay at a relatively moderate level in order for this to happen, believe economists.
“What has to happen is that the lower yen needs to cascade down into greater corporate profits and most importantly into higher wages. This is when people actually feel that deflation is fading and you are getting a more normal behaviour,” said Baader. “The effects of the exchange rate depreciation will flow through for a few years – two to three years – which will allow Japan to regain market share in exports.”
Unprecedented monetary easing by the BoJ has weakened the yen 18% versus the dollar since December 3, according to Bloomberg.
Rising investor appeal
Japan has suspended inflation-linked bonds since 2008 when the global financial crisis caused their prices to plunge. As a result, investors have been extremely cautious when it comes to the issuance of these instruments. However, general sentiment has changed as a result of the so-called ‘Abenomics’.
For example, the breakeven figure for the last batch of six-year JGBi notes – issued back in 2008 – versus conventional bonds have doubled from the end of last year to 130 basis points (bp) on June 11, indicating that appeal of linkers are on the rise.
In previous years, foreign investors held the bulk of JGBis, but experts believe that demand for upcoming issuance of these instruments will primarily come from domestic investors.
“This time you will likely get more of a domestic flavour in terms of investor interest. Foreign participation was dominant in this market going back to four to five years ago, but such positioning was exposed by a dearth of liquidity during the financial crisis,” said André de Silva, head of Asia Pacific rates research at HSBC. "The need to match liabilities and be more prudent provides a natural appetitive for the purchasing of JGBi bonds by the domestic base when they get issued."
Also, the BoJ could also be an active investor in future JGBi issuance.
“One can’t rule out the BoJ taking a page out of the Fed's playbook as well,” said de Silva. “If you draw parallels between the purchasing programme from BoJ under the guidance of QQME [quantitative and qualitative monetary easing], there’s a lot of similarities with the Fed’s programme and going back to the QE2 [second quantitative easing] programme they embarked on buying treasury inflation-protective securities.”
Investors that seek to match assets with liabilities are life insurance companies and pension funds, highlight market participants.
In order to ensure strong investor appetite in linkers, there’s a possibility that the BoJ could tweak some of the JGBi characteristics to include a deflationary floor – which is a common structure for most inflation-linked bonds globally.