Tokyo. The five-year Japanese government bond yield hit its lowest level in about seven years on Friday, supported by recent demand for medium-term notes from cash-rich domestic banks. The JGB market took in stride news that Finance Minister Naoto Kan, a fiscal conservative, would be Japan’s next prime minister. Kan was widely regarded as the front-runner. Although Kan’s views on fiscal and monetary policy are seen as bond-market friendly, there is uncertainty about just how aggressively he will be able to rein in Japan’s rising debt issuance. The five-year JGB yield lost 2 basis points to 0.385 percent, falling to the lowest level since August 2003, a time when the Band of Japan was still carrying out a quantitative easing policy of flooding markets with cash under a liquidity target. “This seems like a continuation of the trend seen over the past couple of days, in which market players led by banks receive short- to medium-term interest rate swaps and buy JGBs in such sectors,” a trader for a European brokerage house said. The looming formation of a new cabinet and Kan’s stance on fiscal and monetary policy may be part of the reason behind the recent buying of medium-term JGBs by domestic banks, but they were mainly doing so to match the durations of their assets to their liabilities, he said. Given that the overnight call rate is now near 0.10 percent, compared to virtually zero percent in August 2003, the five-year yield may have limited room to fall from current levels, market players said. Lead June 10-year JGB futures rose 0.21 points to 140.65, edging back toward a two-year peak of 140.88 hit in late May. The benchmark 10-year JGB yield dipped one basis point to 1.265 percent. Analysts said Kan becoming prime minister was a supportive factor for JGBs. “Kan has spoken out in favor of fiscal consolidation and has also put pressure on the Bank of Japan, so the market’s expectation is that this may lead to additional monetary-easing measures from the BOJ,” said RuiXue Xu, a rates strategist at RBS Securities Japan. “But the market will want to confirm whether or not he will deviate from his prior stance and whether the government will unveil its medium-term framework and long-term targets for fiscal policy in June as scheduled.” The amount of deposits parked at banks is far greater than the loans they are extending, which means domestic financial institutions have surplus cash that they can allocate to JGB investment, market players say. This cash surplus and the upcoming maturing of 9 trillion yen ($97.26 billion) in JGBs in June had contributed to the strength of five-year notes, said Akitsugu Bandou, a senior economist for Okasan Securities. In an illustration of banks’ appetite for JGBs, data compiled by the BOJ shows Japanese money- center banks increased their holdings of JGBs to a record 85.4 trillion yen at the end of March. Last week, a senior portfolio manager for the Bank of Tokyo-Mitsubishi UFJ, which sharply raised its holdings of JGBs with maturities ranging from more than one year to within five years in the fiscal year that ended in March, said the bank was likely to keep the duration of its JGB portfolio at roughly three years in fiscal 2010-11.

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