JGBs gain as consumer inflation falls below zero

The Japanese government bonds gained on Friday after data showed weaker than expected April consumer inflation figure, which intensified pressure on Bank of Japan (BoJ) for further stimulus. Also, weak crude oil prices supported the bond prices. The yield on the benchmark 10-year bonds, which moves inversely to its price fell 1bp to -0.112 percent and the yield on short-term 2-year bonds also dipped 1bp to -0.236 percent by 0530 GMT.

Japan’s consumer prices dropped for a second month as central bank Governor Haruhiko Kuroda struggles to spur inflation with record asset purchases and negative interest rates. Japan April headline CPI fell 0.3 percent y/y, market consensus was for a decrease of 0.4 percent, from down 0.1 percent in March. National CPI y/y excluding fresh food for April fell 0.3 percent y/y, against market expectation 0.4 percent fall, compared to -0.3 percent in March. Moreover, the National CPI excluding food, energy y/y for April rose 0.7 percent y/y, while expectation was for 0.7 percent, from 0.7 percent in March.

In addition, the BoJ's own April national CPI ex-fresh food & energy rose 0.9 percent y/y, lower than the market consensus of 1.0 percent y/y, from 1.1 percent in March. This lack of price growth will intensify pressure on the Bank of Japan to consider further monetary stimulus after Kuroda disappointed the markets by taking no action at April’s meeting. The BOJ next meets June 15-16, with its monetary policy decision one day after the Fed's decision (meets June 14-15). Interestingly, both decisions come just ahead of the UK Brexit referendum vote June 23.

Moreover, the Japanese bonds have been closely following developments in oil markets because of their impact on inflation expectations, which are well below the Bank of Japan's target. Today, crude oil prices fell below $50 mark after investors booked profit, as they considered whether higher prices could unlock more output in an already oversupplied market. Yesterday, crude oil prices crossed $50 mark for first time in seven months after the U.S. government reported a larger-than-expected drop in crude inventories. According to the US DOE, crude inventories decreased 4.2 million barrels, as compared to a build of +1.3 million barrels seen prior for the week ending 20 May. This came alongside an increase seen in gasoline inventories of +2.0 million barrels, from a draw of -2.5 million barrels seen prior and a decrease in distillate inventories of -1.3 million barrels, against a draw of -3.2 million barrels. The International benchmark Brent futures fell 0.85 pct to $49.17 and West Texas Intermediate (WTI) dipped 0.77 pct to $49.10 by 0530 GMT.

Today, the BoJ bought JPY240 billion of 10-25 year JGBs and JPY160 billion of 25-40 year JGBs, including the new 40s, under its massive JGB purchase program. Moreover, the BoJ's adoption of negative rates in January has driven JGB yields below zero, while also increasing its market volatility. Further, we expect an expansion of stimulus, and if the market happens to rule out any additional boost in stimulus, that would create an opportunity to go long and we also foresee that the 10-year note will yield about -0.15 pct at year-end. Meanwhile, the benchmark Nikkei 225 index trading up 0.36 percent at 16,832.46, and the broader Topix index higher 0.53 percent at 1,350 points by 0550.