Oil, inflation threaten Japan Inc spreads
Japanese bond investors have been slow to recognise the inflationary threat from record high oil prices, and an expected squeeze on corporate profits from steep commodity prices should push credit spreads wider in coming months.
By Agencies |
TOKYO: Japanese bond investors have been slow to recognise the inflationary threat from record high oil prices, and an expected squeeze on corporate profits from steep commodity prices should push credit spreads wider in coming months.
Unnerved by expectations that growing inflationary pressure could prompt the Bank of Japan to raise interest rates later in the year, some investors have bought default protection via credit derivatives and nudged out credit spreads.
While Japanese government bond market have tumbled and yields have soared to 10-month peaks on the mounting worries about inflation, the widening in credit spreads has been moderate, especially compared with the worst of the credit crisis in March.
One reason the credit market is slow to react to inflation worries is that Japanese shares, whose gains tend to push credit spreads tighter, have jumped to five-month highs. But the sanguine mood in the credit default swaps (CDS) market is unlikely to last for much longer, analysts said.
"CDS spreads are expected to widen, and higher oil prices are likely to play a big role in it," said Mana Nakazora, head of credit research at JPMorgan Securities. With many Japanese firms assuming a crude oil cost of roughly $110 a barrel in the current fiscal year ending in March 2009, they may not meet their profit targets at current levels, let alone higher ones, Nakazora said.
US crude has pulled back to around $128 a barrel from a peak near $135 but since the start of the year it is still up $32 and has nearly doubled from where it was a year ago. The benchmark five-year iTraxx CJ index -- made up of the CDS spreads on 50 Japanese investment-grade companies -- was at 84/86 basis points on Friday, up around 20 basis points from four-month lows hit near 60 basis points a little over two weeks ago. At the worst of the credit crisis in mid-March when U.S. investment bank Bear Stearns collapsed, the iTraxx CJ index soared to all-time highs around 250 basis points -- a level that had more to do with speculators dumping positions than higher credit risk in Japan.
"The index is highly unlikely to surge back to the levels reached in March," said Tomonori Sasaki, credit analyst at Shinko Securities Signs of damage to the earnings of oil-dependent companies will likely start showing up in the April-June quarter, analysts said. Some of the potential victims include Japan Airlines, automakers, pulp/paper and shipping firms.
The surge in oil prices is one reason why JAL's benchmark CDS spreads at 430 basis points, have stayed near their widest levels this year even as other corporate spreads have recovered and credit agencies have a stable or positive outlook on its junk ratings. Some of the pain was seen in this week's data on first-quarter corporate profits in the Ministry of Finance's quarterly survey. Profits across industries and companies fell 17.5 percent year-on-year in the first quarter, accelerating from a 4.5 percent decline in the previous quarter.
Economists at Nikko Citigroup said in a note to clients that the squeeze on profit from higher energy and raw material costs will remain quite strong during the second and third quarters of the year but should ease a bit after that. CDS spreads are also expected to widen if the BOJ is seen as more likely to lift interest rates to control inflation. An eventual tightening of monetary policy would risk hobbling an economy that is already losing its momentum.
"A BOJ rate hike at a time of stagflation-like situation like now would prompt investors to question the ability of the central bank to maneuver policy," said a senior trader at a leading Japanese brokerage. "That would immediately boost CDS spreads." Swap contracts on the overnight call rate show a 50-50 chance of the BOJ increasing interest rates to 0.75 percent from the current 0.5 percent by year-end, and they are fully pricing in a move by April 2009. One reason is inflation. After a temporary slowdown in April, some economists expect Japanese core consumer prices to reach a 1.8 percent to 2.0 percent annual rate later in the year, topping the decade-high of 1.2 percent hit in March.
Unnerved by expectations that growing inflationary pressure could prompt the Bank of Japan to raise interest rates later in the year, some investors have bought default protection via credit derivatives and nudged out credit spreads.
While Japanese government bond market have tumbled and yields have soared to 10-month peaks on the mounting worries about inflation, the widening in credit spreads has been moderate, especially compared with the worst of the credit crisis in March.
One reason the credit market is slow to react to inflation worries is that Japanese shares, whose gains tend to push credit spreads tighter, have jumped to five-month highs. But the sanguine mood in the credit default swaps (CDS) market is unlikely to last for much longer, analysts said.
"CDS spreads are expected to widen, and higher oil prices are likely to play a big role in it," said Mana Nakazora, head of credit research at JPMorgan Securities. With many Japanese firms assuming a crude oil cost of roughly $110 a barrel in the current fiscal year ending in March 2009, they may not meet their profit targets at current levels, let alone higher ones, Nakazora said.
US crude has pulled back to around $128 a barrel from a peak near $135 but since the start of the year it is still up $32 and has nearly doubled from where it was a year ago. The benchmark five-year iTraxx CJ index -- made up of the CDS spreads on 50 Japanese investment-grade companies -- was at 84/86 basis points on Friday, up around 20 basis points from four-month lows hit near 60 basis points a little over two weeks ago. At the worst of the credit crisis in mid-March when U.S. investment bank Bear Stearns collapsed, the iTraxx CJ index soared to all-time highs around 250 basis points -- a level that had more to do with speculators dumping positions than higher credit risk in Japan.
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"The index is highly unlikely to surge back to the levels reached in March," said Tomonori Sasaki, credit analyst at Shinko Securities Signs of damage to the earnings of oil-dependent companies will likely start showing up in the April-June quarter, analysts said. Some of the potential victims include Japan Airlines, automakers, pulp/paper and shipping firms.
The surge in oil prices is one reason why JAL's benchmark CDS spreads at 430 basis points, have stayed near their widest levels this year even as other corporate spreads have recovered and credit agencies have a stable or positive outlook on its junk ratings. Some of the pain was seen in this week's data on first-quarter corporate profits in the Ministry of Finance's quarterly survey. Profits across industries and companies fell 17.5 percent year-on-year in the first quarter, accelerating from a 4.5 percent decline in the previous quarter.
Economists at Nikko Citigroup said in a note to clients that the squeeze on profit from higher energy and raw material costs will remain quite strong during the second and third quarters of the year but should ease a bit after that. CDS spreads are also expected to widen if the BOJ is seen as more likely to lift interest rates to control inflation. An eventual tightening of monetary policy would risk hobbling an economy that is already losing its momentum.
"A BOJ rate hike at a time of stagflation-like situation like now would prompt investors to question the ability of the central bank to maneuver policy," said a senior trader at a leading Japanese brokerage. "That would immediately boost CDS spreads." Swap contracts on the overnight call rate show a 50-50 chance of the BOJ increasing interest rates to 0.75 percent from the current 0.5 percent by year-end, and they are fully pricing in a move by April 2009. One reason is inflation. After a temporary slowdown in April, some economists expect Japanese core consumer prices to reach a 1.8 percent to 2.0 percent annual rate later in the year, topping the decade-high of 1.2 percent hit in March.
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