ECB rate call may spur Japanese euro-denominated bonds
* JFM and DBJ consider euro-denominated bond issues
* Move comes as cost to convert euros to yen drops
* Further ECB monetary stimulus may increase the appeal
By Frances Yoon
HONG KONG, May 28 (IFR) - Japanese borrowers will pay close close attention to the European Central Bank's interest rate decision next week as they consider forays into the euro-denominated debt market.
The ECB is expected to cut rates among other policy measures to support the eurozone economy when it meets June 5. The moves could continue to make euro-denominated debt cheaper than US dollar debt to Japanese state-owned entities, and may spur borrowers like the Japan Finance Organization for Municipalities (JFM) and the Development Bank of Japan (DBJ) to sell bonds in Europe.
JFM, for one, is examining the possibility of issuing a non-guaranteed benchmark global bond in euros for the first time. The agency's last four bond issues have been five-year US dollar offerings.
"We are looking to further diversify our investor base and are looking at benchmarks in longer tenors," Atsuhito Tanaka, the director-general of JFM's finance department, said. "In the euro market, seven and 10-year tenors are benchmark tenors."
Tanaka indicated, however, that its first bond of the fiscal year, which JFM expects to sell around July, may still be issued in US dollars. But the issuer is keen to discover different markets to tap new investors. If JFM moves to euros, other agencies may follow suit.
The top motivation for Japan's agencies is cost. The price of selling a euro-denominated bond is cheaper now than selling a US dollar bond if the proceeds are swapped to yen.
That is because the cross currency basis swap between the euro and yen dropped below the swap between the US dollar and the yen in mid-April for the first time in several years.
The move in the basis swap is the result of investment flows moving out of Europe amid expectations the central bank will lower interest rates.
Because more money has fled euros for dollars, the five-year cross-currency basis swap between the yen and US dollar fell to -47.6 on May 22 from -58bp at the end of last year. The closer the swap is to zero, the more expensive it is for Japan's bond issuers to swap US dollar proceeds to yen.
The swap contract between the euro and yen has been stuck at -45bp for most of this year.
While the appetite of global investors for European assets seems to be simmering down, judging by the move in the basis swap, it remains unchanged for Japan.
Until recently, that was not the case. Since last May, when the Federal Reserve first hinted it would scale back its efforts to stimulate the US economy, the yen and euro moved in similar directions against the dollar.
That correlation has shifted since March, when the euro hit its highest level since October 2011 and the yen remained in a range of ¥101 to ¥103 per US dollar.
The shift is making it cheaper for Japanese companies to sell euro-denominated bonds.
Besides the lower cost of converting debt proceeds back to yen, yields in Europe also have continued to drop, making overall funding costs lower. In May Germany issued 10-year bonds with a 1.37% coupon, one of its lowest ever.
JFM has not been the only one to notice the cheaper funding costs in Europe. Some of Asia's most frequent issuers such as the Export-Import Bank of Korea and Korea Development Bank also are expected to sell euro-denominated bonds after the Republic of Korea issues a sovereign bond in June that could come in euros, according to sources.
Korea National Oil Corp already made it official, mandating Barclays, BNP Paribas, Citigroup, Deutsche Bank and Societe Generale to lead a euro-denominated bond earlier this week.
European investors are likely to welcome new borrowers to the market, yet a bond from JFM will test commonwealth attitudes towards Abenomics and the future of Japan.
Standard & Poor's has a negative credit outlook on Japan amid warnings of ballooning government debt, already one of the highest among developed nations. Fitch, which slashed the sovereign's rating in May 2012 from AA-, also has warned of the possibility of further downgrades unless Japan's public finances stabilize.
Moody's has a stable outlook on Japan, but said its macroeconomic future will depend on the implementation of structural growth policies. Japan is rated Aa3/AA-/A+ by Moody's, S&P and Fitch respectively.
Japanese issuers have expressed confidence that despite rating agency views they will be able to attract investors.
"Some investors have mentioned the risk from the government, however, I don't see that as a negative point right now and we expect the investor stance not to be affected," said Yasuhiro Matsui, director of the DBJ's treasury department.
"The direction of the economy is on a positive track, and we see macro fundamentals improving," said JFM's Tanaka. "The raise in the consumption tax will also help improve the financial conditions," he said, referring to an April 1 increase in Japan's sales tax to 8% from 5%.
The DBJ, which is government owned, is among borrowers that may tap the euro-denominated market.
The bank is planning two benchmark deals in the offshore markets this fiscal year worth the equivalent of US$1.5bn. It is looking into bonds that meet socially responsible investing criteria, such as green bonds, as well as covered bonds. Both kinds of securities are more common in Europe.
"US monetary policy has been affecting the basis swap, which had been preferable for nearly two years," the DBJ's Matsui said. "However, that is recently shrinking gradually. It could shrink even further." (Reporting By Frances Yoon; editing by Christopher Langner and Abby Schultz)