Yen Swap Spreads Near Record as Hedge Funds Stay Away, RBS Says

Date: Tuesday, March 17, 2009
Author: Bloomberg.com

Japan’s attempts to end financial turmoil failed to lure hedge funds back to its swap markets, leaving premiums paid by domestic borrowers near a record, RBS Securities Japan Ltd. said.

Hedge funds, which lost more than $400 billion through withdrawals and market losses since June, pulled out of Japan’s swap markets after the failure of Lehman Brothers Holdings Inc. led to a seizure in global credit, said Tatsuo Ichikawa, a senior strategist at RBS in Tokyo. Japan’s banks were charged record premiums this month to swap London borrowing rates for those set in Tokyo as a slumping economy exacerbated concern about the health of the nation’s companies.

“Hedge funds are pulling money out of the market and aren’t in a position to take risks,” Ichikawa said. “There’s also the possibility that foreign financial institutions operating in Tokyo are repatriating funds to their home countries. This makes it easy for the market to overshoot and it will take time for conditions to return to normal.”

Spreads are near all-time highs for swaps covering interbank borrowing costs, credit risk and cross-currency transactions. Japanese banks were asked to pay as much as 35 basis points this month on top of the yen London Interbank Offered Rate, or Libor, to receive the yen rate set in Tokyo. That was the largest gap since at least May 1999 and also exceeded levels following Japan’s banking crisis in the 1990s.

Japan Premium

Investors exchanging yen for dollar funds are accepting interest payments 55 basis points below Libor for the Japanese currency, according to data compiled by Bloomberg. The spread reached a record low of 86 basis points last month as the crisis made it harder for Japanese companies to borrow dollars.

“The swap market’s moves are definitely abnormal, but there aren’t any firms that can take on the risk to place the opposite bet,” said Tokuyoshi Takano, manager of the financial derivatives section at Mitsui Sumitomo Insurance in Tokyo.

Spreads may have widened as the volume of swap transactions declined after foreign securities firms closed their structured- note desks in Japan, according to RBS’ Ichikawa.

Twenty-year yen interest-rate swap rates are 22 basis points below yields on similar-maturity government debt, narrowing from a record 45 basis points on Oct. 10. The spread may shrink to 10 basis points and then widen again, said Reiko Tokukatsu, a bond strategist at JPMorgan Chase & Co. in Tokyo.

“Conditions are not right for hedge funds to return,” Tokukatsu said. “The market’s liquidity cannot recover on its own and is being supported by the central bank.”

To contact the reporter on this story: Saburo Funabiki in Tokyo at sfunabiki@bloomberg.net; Nate Hosoda at nhosoda@bloomberg.net