Japan's Notes Rise, Set for Biggest Quarterly Rally in a Year

Sept. 28 (Bloomberg) -- Japan's five-year government notes advanced, heading for the biggest quarterly rally in a year, after reports showed a slump in the housing market in the U.S. and a decline in consumer prices in Japan.

Yields fell from a six-week high after the reports prompted traders to cut bets the Bank of Japan will raise interest rates this year. Japan's bonds have returned 1.4 percent this quarter, according to a Merrill Lynch & Co. index, as losses tied to U.S. subprime mortgages sparked demand for government debt.

``It will take time to fully wipe out concerns over the subprime problem and housing slump in the U.S.,'' said Shinji Kunibe, a fund manager in Tokyo at the local unit of JPMorgan Asset Management, which oversee $847 billion in assets. ``A rate increase this year is a tough call under these situations.''

The yield on five-year notes fell 5 basis points to 1.2 percent at 11 a.m. in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price on the 1.1 percent debt due September 2012 rose 0.233 yen to 99.531 yen.

Five-year yields slid from 1.255 percent yesterday, the highest since Aug. 14. For the quarter, yields have fallen about 25.5 basis points. A basis point is 0.01 percentage point.

Treasuries rose yesterday on a Commerce Department report showing the pace of new U.S. home sales fell 8.3 percent to an annual rate of 795,000 last month from a revised 867,000 in July.

Consumer Prices

``Japanese bonds may track the rally in U.S. Treasuries,'' said Makoto Yamashita, Tokyo-based chief bond strategist at Lehman Brothers Japan Inc., one of the 25 primary dealers that are required to bid at auctions. Yamashita said he recommends investors to pick up bonds with 10-year yields above 1.65 percent for the next two weeks.

Trader pared bets that the Bank of Japan will increase rates in October, after a government report today showed consumer prices fell for a seventh month. Core consumer prices excluding fresh food declined 0.1 percent in August from a year earlier, matching the median estimate of 45 economists surveyed by Bloomberg News.

Investors see an 8 percent chance of a rate increase at the central bank's next meeting on Oct. 10-11, down from 9 percent yesterday, according to Credit Suisse Group calculations using overnight index swap rates.

Gains in bonds may be limited by speculation an increase in stocks will erode demand for government debt. The Nikkei 225 Stocks Average has gained 3.1 percent so far this week, heading for the biggest rally in a month.

Stocks Pressure Bonds

Japan's bonds often move in the opposite direction of stocks. Benchmark 10-year yields had a correlation of 0.91 with the Nikkei 225 in the past month, according to Bloomberg data. A value of 1 means the two moved in lock step.

``There's no reason to be bearish on the Nikkei,'' said Hitomi Kimura, a bond strategist at JPMorgan Securities Japan Co. in Tokyo. ``If we break 17,000, there will be more pressure on bonds.'' The Nikkei 225 declined 0.3 percent to 16,783.98.

A separate government report showed Japan's industrial production surged at the fastest pace in almost four years in August. Production climbed a seasonally adjusted 3.4 percent from July, the Ministry of Economy, Trade and Industry said in Tokyo today. The median estimate of 47 economists surveyed by Bloomberg News was for a 3 percent increase.

A technical chart that traders use to predict price changes suggests bonds may rebound. The seven-day relative strength index on 10-year yields was 75 yesterday. A level above 70 implies selling of the security may have lost momentum.

The yield on the benchmark 10-year bond fell 5 basis points to 1.67 percent. Ten-year bond futures for December delivery climbed 0.53 to 134.97 in Tokyo.