Rush for safety drives government bond yields lower despite Japan debt concerns

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Government bonds are playing their traditional role as a hiding place on Monday, despite concerns that heavily indebted Japan will have to borrow huge new amounts to fund rebuilding after Friday’s devastating earthquake.

Yields fell sharply on bonds in Japan and Europe, and U.S. Treasury yields also were lower on short- and intermediate-term issues, amid fresh worries about the health of the global economy.

The five-year U.S. T-note yield (charted below) was at 1.97% at about noon PDT, down from 2.05% on Friday and a six-week low.

Longer-term U.S. Treasury yields were modestly lower. The 10-year T-note yield, a benchmark for mortgage rates, was at 3.35%, down from 3.40% on Friday.

Federal Reserve policymakers, meeting on Tuesday, are expected to reaffirm their commitment to finishing the $600-billion Treasury-bond-buying program launched in November.

In Japan, already the home of the world’s lowest interest rates, government bond yields fell further as money fled stocks. The Nikkei-225 share index plummeted 6.2% to a four-month low of 9,620.

The yield on five-year Japanese government bonds slid to a two-month low of 0.49% from 0.56% on Friday.

The Bank of Japan poured a record $183 billion into the financial system on Monday to keep the credit wheels greased as the economy reels from the quake and the tsunami that followed. The BOJ also said it would launch new purchases of government bonds beginning Wednesday.

Government bond yields in Europe fell after the European Union on Friday agreed to expand its bailout fund for financially distressed countries, allowing the fund to make direct purchases of the countries’ bonds. Five-year Portuguese bond yields sank to 7.76% from 7.99% on Friday.

For Japan, the longer-term question is whether the government will be able to borrow aggressively to pay for rebuilding without driving up bond yields. Government debt in Japan already is more than 200% of gross domestic product.

Historically, the advantage the Japanese government has had is that its own people and institutions have bought nearly all of its debt. That’s critical, because it’s unlikely the rest of the world would accept the country’s rock-bottom interest rates.

But that raises another question: Will the Japanese government and private investors sell some of their extensive U.S. Treasury holdings to help raise yen for the rebuilding effort?

That could boost the risk of rising Treasury yields this spring, particularly if the Federal Reserve ends its bond-buying program as scheduled in June. Concern about the wind-down of Fed buying, along with stronger economic data, had helped push Treasury yields higher in early February.

For now, though, investors’ desire for safety is trumping everything else.

-- Tom Petruno