As fund managers snap up Japanese government bonds from a rapidly shrinking pool, there’s one security going unloved - inflation-linked debt.
The Ministry of Finance announced last week it will cut linker issuance for the first time since restarting sales in October 2013 after investors joined primary dealers in lobbying for the reduction.
The debt has lost 1.5% this year, as nominal bonds have returned 4.6% in their best quarter since 1995, according to Bank of America Merrill Lynch indexes. A gauge of US Treasury Inflation-Protected Securities has returned 4.4%.
The lack of demand for linkers reflects a year of stagnation in a consumer price benchmark that the central bank is seeking to push to 2%.
A bond market measure of inflation expectations over the next decade known as the breakeven rate stands at just 0.36% after slumping as low as 0.13% last month.
That adds to signs Prime Minister Shinzo Abe’s stimulus is failing, including the worst drop in factory production since the 2011 earthquake and the biggest slide in retail sales since a consumption-tax hike in 2014.
“My impression is that the government admitted defeat,” Noriatsu Tanji, a senior bond strategist at Mizuho Securities Co in Tokyo, said of the decision to cut linker issuance. “The breakeven rate looks quite cheap, but investors aren’t willing to buy linkers out of fear they won’t be able to sell them if they want to later on.”
The Finance Ministry will offer ¥400bn ($3.6bn) of bonds in each of four auctions in the fiscal year beginning April, down from ¥500bn previously.
It brings the sales back to the level they were at in September 2014, when the ministry said primary dealers might welcome sales of up to 600bn yen per auction.
The decision to reissue linkers after a five-year hiatus was a signal of Abe’s resolve to end more than a decade of deflation through his so-called three arrows strategy of monetary easing, fiscal stimulus, and economic reforms.
Bank of Japan Governor Haruhiko Kuroda has overseen three rounds of stimulus since April 2013 that included the surprise introduction of negative interest rates this year.
Over that time, the yen slumped to a 13-year low to the dollar and JGB yields fell to records across maturities as the central bank scooped up an unprecedented one-third of outstanding debt through its quantitative-easing programme.
Even so, Kuroda finds himself almost as far from his inflation goal as he was when he started, forcing him to extend his time frame for reaching it twice last year.
“Getting rid of the deflationary mindset is very difficult,” said Naoya Oshikubo, a rates strategist at Barclays in Tokyo. “It’s undeniable that the negative interest-rate policy has had a pronounced effect in pushing down yields, but whether it will work to push up inflation remains unclear.”
Kuroda said this month that there is “a lot of room” in theory to cut the deposit rate from the current minus 0.1%. He also said that the decline in Japan’s interest rates is exactly what the BoJ intended, and will have a “positive impact” on asset prices.
The yield on the benchmark 10-year JGB was at minus 0.085% on Thursday in Tokyo, the lowest rate globally after Switzerland. It dropped to a record minus 0.135% on March 18.
A Ministry of Finance official told reporters last week that investors demand a liquidity premium for linkers amid increasingly thin trading, resulting in market conditions that are worse than fundamentals such as oil prices would suggest.
Crude oil has rebounded to around $40 per barrel since dipping below $28 at the start of the year for the first time since 2003. Even so, Japan’s 10-year breakeven rate has lagged gauges in other developed markets, and is the lowest among 13 tracked by Bloomberg.
“Disinflation is a global phenomenon now, but Japan is still the leader,” said Masayuki Koguchi, the chief yen-bond fund manager at Mitsubishi UFJ Kokusai Asset Management in Tokyo. “Governor Kuroda’s intention isn’t getting through to the bond market.”