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Markets

Samurai bond yields jump as investors fear end to easy money

Market players see 'the party' winding down in one to two years

Yen-denominated bonds Credit Agricole issued Friday had wider swap spreads than ones European peers floated earlier this year.   © Reuters

TOKYO -- Bearish sentiment is taking root in the corporate bond market on smoldering fears that the debt bubble formed by widespread monetary easing will soon deflate.

"We're just anxiously trying to figure out when this party will end," said a corporate-bond specialist at a Japanese asset manager.

So far this year, yields have risen not just for U.S. investment-grade corporate bonds, but for emerging-market and European bonds as well. Several direct causes such as political instability and supply-demand imbalances drove the increases, but more than a few investors nevertheless believe the bubble is already deflating.

Though geopolitical risk has settled somewhat in recent days with Italy's formation of a governing coalition and the International Monetary Fund's deal to support Argentina, unease has reached even Japan's relatively calm bond market, where yields are jumping on "samurai bonds," yen-denominated debts issued in Tokyo by non-Japanese companies.

Yields on five-year, non-prime preferential samurai bonds issued Friday by France-based Credit Agricole were 50 basis points above a key reference rate, about 30 basis points wider than those on similar bonds that other European lenders floated in January and February. Pension funds tempted by rising yields in Southern European government bonds withdrew their offers all at once, said a source at a Japanese brokerage.

The so-called swap spread tends to widen when investors become sensitive to credit risk on the part of the issuer or demand thins out. The spread on 10-year samurai bonds issued this month by Corning, a U.S.-based materials science company that has a relatively risky BBB+ credit rating from Standard & Poor's, is greater than on those the company floated last August, for instance. Some already-issued bonds, including debt of Spanish banks, also face heavy selling.

With the U.S. continuing to tighten monetary policy and Europe looking to wrap up easing, markets "have entered a phase in which bonds are prone to being sold to get out ahead of economic retreat," said Osamu Takashima at Citigroup.

Despite general calm in the Japanese corporate bond market, with relatively few low-rated issues, "there's no guarantee you'll continue to be able to sell anytime you want," warned Haruyasu Kato of Asset Management One.

Increasing numbers of risk-off investors have "trimmed our position on samurai bonds as well as low-rated and low-liquidity issues," in the words of a representative at Daiwa SB Investments. Meanwhile, the yield spread for corporate bonds with relatively safe AA ratings has narrowed to the mid-22-basis-point range on average, suggesting investors are fleeing toward safer bets.

When bond selloffs will begin in earnest is unclear, but economic wisdom holds that the bond market will cross its peak before stocks do. The global bond market will likely enter a downward phase around September, Morgan Stanley has posited, based on asset price movements in past recessions.

An immediate, drastic shift is unlikely, say some. Citigroup's Takashima likened current conditions to the period between the end of the 1990s -- which saw the Asian financial crisis and the collapse of Long-Term Capital Management, a U.S. hedge fund that had taken on a huge profile in global finance -- and the burst of the dot-com bubble in 2001.

During that period, with the global economic cycle approaching recession, rising U.S. interest rates shook investors. Thereafter, as rates dropped again, bond prices cycled between drops and lulls. The present situation likewise "will take at least one to two years" to completely turn around, Takashima estimates.

If the market becomes seriously unstable, hopes probably will emerge that Europe will delay its easing exit. "The market will probably continue wavering between optimism over central bank policies and pessimism fueled by unease about the bond bubble bursting," said Mana Nakazora at BNP Paribas Securities (Japan).

"The time to run away quickly hasn't come yet," said an investment point person at a life insurer, who said the company had recently "picked back up some of the issues we had sold heavily." But the market has come more awake to the risk of picking bonds for yield alone.

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