Japanese expected to take their cash elsewhere

SYDNEY - Expectations of more US interest rate rises are likely to slash demand for bonds targeted at Japanese retail investors - known as uridashis - denominated in Australian and New Zealand dollars.

Analysts say unfavourable currency shifts and rising US and Japanese bond yields are making Australian and New Zealand dollar offerings less attractive to the Japanese, who had been keen to ship their cash offshore while domestic banks were offering interest rates close to zero.

The Federal Reserve raised the US fed funds rate to 4.75 per cent from 4.5 per cent this week, as widely expected, and the central bank suggested it would raise rates at least once more to 5 per cent in May.

The US rate outlook, more aggressive than many investors had expected, will cut the rate advantages on uridashi bonds from Australia and New Zealand.

Many expect the Japanese investors to take their cash elsewhere.

"The further that the Fed takes fed funds and the front end of the curve, the more attractive US-dollar-denominated debt will become to Japanese retail investors," said Robert Rennie, chief strategist at Westpac.

Japanese retail investors started eyeing the high interest rates on offer in Australia and New Zealand five years ago as Japan flooded its banking system with cash to try to rekindle growth and interests rates faded to almost nothing.

Although aussie and kiwi bonds still offer significantly higher yields than Japanese Government bonds, this month's decision by the Bank of Japan to end its ultra-soft monetary policy has pushed yields on Japanese 10-year bonds to their highest since August 2004.

This has only lifted the yield to around 1.75 per cent, compared with Australia's 10-year bond yield of around 5.4 per cent, but the sliding aussie dollar has cut into returns for Japanese investors, raising the risk they won't get all their yen back when the bonds mature.

Furthermore, US 10-year yields are now around 4.8 per cent, not far from Australian yields and in a currency that has held its ground against the yen this year.

The loss of yield advantage has dragged on the aussie dollar, which fell to an 18-month low of US70.15c on Wednesday, taking the currency's losses this month to 5.5 per cent against the US dollar and nearly 4 per cent against the yen. It was trading yesterday around US71c.

New Zealand has the highest interest rates in the developed world, with a cash rate of 7.25 per cent, but its economy contracted in the final quarter of last year and its currency has tumbled 9 per cent this month against the US dollar and 8 per cent against the yen.

While the amount of uridashi redemptions in kiwi dollars is smaller than in aussie dollars over the next few months, the tempo increases in late 2006 - at a time when economists expect the central bank to start cutting rates in a weakening economy.

And over 2007, Rennie calculates redemptions of kiwi dollar uridashi and eurokiwi bonds at $16 billion. "It's a scary number," he said.

- REUTERS