Japan's Notes Halt Two-Week Rally on Concern Rates to Increase

Japan's five-year notes fell this week
on speculation the central bank will increase interest rates again
this year to prevent excessive investment and asset bubbles.

Notes halted a two-week rally after Bank of Japan Governor
Toshihiko Fukui yesterday said borrowing costs are ``very low''
given the economy's strength. Next week, BOJ board members will
vote on rates at a two-day policy meeting and the government will
announce figures for first-quarter economic growth.

``Fukui's comments this week made it clear that the bank
hasn't weakened its determination to increase rates,'' said
Akitsugu Bandou, a senior strategist at Okasan Securities Co. in
Tokyo, one of the 25 primary dealers that are required to bid at
government auctions. ``Selling pressure is hitting the short-dated
debt hardest and people can't get bullish about bonds.''

Yields on five-year notes, which move inversely to prices,
rose 4 basis points this week, according to Japan Bond Trading Co.,
the nation's largest interdealer debt broker.

The yield on the 1.2 percent note due in March 2012 today
declined 2 basis points to 1.225 percent. It yesterday touched
1.25 percent, the highest since April 23. Ten-year bond yields
increased 2 basis points this week to 1.645 percent. A basis point
is 0.01 percentage point.

Central Banks

``If we neglect to implement needed rate adjustments, that
may accentuate risks to the economy that may not be so prominent
otherwise,'' Fukui said at meeting of business executives in Tokyo
yesterday. The BOJ raised its target for overnight lending rates
by a quarter percentage point to 0.5 percent in February.

The Bank of Japan bank may lift rates again between July and
September, Okasan's Bandou said.

Five-year notes yesterday fell for a fifth day, the longest
decline since December, on speculation a Federal Reserve decision
this week to keep borrowing costs at a six-year high will make it
easier for the Bank of Japan to raise rates.

The spread between 10-year government bonds in Japan and the
U.S. was 296 basis points, near the average for the past year. The
gap in yields is likely to stay near 300 basis points next week as
Japan's bonds track U.S. Treasuries, said Akio Kato, an investor
in Tokyo at Kokusai Asset Management Co., which runs the world's
second-largest bond mutual fund.

Japanese benchmark bond yields had a correlation of 0.88 with
U.S. 10-year note yields in the past year, according to Bloomberg
data. A value of 1 means the two moved in lock step.

Spread Narrows

Five-year notes fell at a faster pace than did longer debt as
traders priced in the probability that rates will rise this year,
said Akio Kato, an investor in Tokyo at Kokusai Asset Management
Co., which runs the world's second-largest bond mutual fund.

The spread between five- and 10-year debt narrowed to 41.8
basis points earlier today, the tightest gap since Dec. 27,
flattening the so-called yield curve.

An index of Merrill Lynch & Co. showed bonds maturing in 10
years or longer returned 0.33 percent in the past month, while
shorter tenors returned 0.04 percent.

Ten-year yields near 1.7 percent may attract buyers, said Jun
Fukashiro, a bond fund manager in Tokyo at Toyota Asset Management
Co., which holds the equivalent of $10 billion in assets. The
yield hasn't risen above 1.7 percent since April 18.

A sale of 10-year debt on May 8 drew the highest demand since
February 2005 and a Ministry of Finance report yesterday showed
overseas investors purchased more Japanese bonds than they sold
for a third week.

Five-Year Auction

Traders may try to push up five-year yields before an auction
of the securities next week, according to Akihiko Inoue, a market
analyst in Tokyo at Mizuho Investors Securities Co.

The Ministry of Finance will sell 2 trillion yen ($16.6
billion) of the notes on May 15. Yields in pre-auction trading
yesterday suggested the ministry may set a 1.3 percent coupon, the
highest since January.

``Investors may demand higher yields before buying as the
economic figures in the coming weeks may show signs of a
recovery,'' said Inoue, whose company is one of the 25 primary
dealers that are required to bid at government auctions.

To contact the reporter on this story:
Issei Morita in Tokyo at .

Softbank Default Swaps May Drop, Morgan Stanley Says (Update2)

Investors may make more bets on the
improving finances of Softbank Corp., Japan's third-largest
mobile-phone company, by selling credit-default swaps, Morgan
Stanley Japan Securities Co. said.

Sellers of the derivatives, which provide buyers with
protection from a firm's inability to repay debt, are attracted
by a price that overstates the chance Softbank will fail to meet
its obligations, said Hidetoshi Ohashi, a Morgan Stanley credit
analyst in Tokyo. The extra yield investors demand to hold
Softbank bonds over Japanese swap rates has halved in the past
year. Spreads on Softbank credit-default swaps fell by a quarter.

Softbank said on May 8 its fourth-quarter operating profit
more than doubled, helping allay concern that it would be unable
to repay loans that funded its 1.66 trillion yen ($13.8 billion)
acquisition of Vodafone Group Plc's Japanese mobile-phone unit.
The purchase in April last year extended billionaire Masayoshi
Son's challenge to market leaders NTT DoCoMo Inc. and KDDI Corp.

``The company's earnings showed the mobile phone businesses
are doing better than anticipated,'' said Ohashi, the third-
highest-ranked credit analyst in Japan, according to a survey by
Nikkei Bonds and Financial Weekly. ``Investors are selling
Softbank CDS to earn income because cash bonds are expensive
relative to the CDS premium.''

Narrowing Spreads

Credit-default swaps based on 1 billion yen of Softbank debt
closed in Japan at 25.8 million yen from 26.3 million yen
yesterday, according to prices from JPMorgan Chase & Co. Trading
volume today between dealers was about 8 billion yen, more than
five times the normal daily amount, said Mana Nakazora, chief
credit analyst at JPMorgan Securities Japan in Tokyo.

The cost of the contracts was as much as 39.6 million yen
in March 2006, the highest since Bloomberg began tracking the
contracts in February 2005. Sellers of the five-year contracts
receive quarterly payments because they agree to pay buyers the
face value of the notes in a default in exchange for the
underlying securities.

The cost of the five-year contracts is equivalent to 258
basis points, or 2.58 percent of the amount protected. The cost
may fall below 200 basis points in the next six to 12 months,
Morgan Stanley's Ohashi said.

The yield spread between the company's 40 billion yen in
1.98 percent bonds due in September 2010 and similar-maturity
swap rates narrowed to 166 basis points yesterday, from 333 basis
points a year earlier, according to data compiled by Bloomberg.

Operating profit rose to 73.8 billion yen in the three
months ended March 31 from 34.4 billion yen, and sales more than
doubled to 721.9 billion yen, Tokyo-based Softbank said on May 8.

BBB Rating

Softbank's debt carries a BBB ranking from Japan Credit
Rating Agency, the second-lowest investment grade. Moody's
Investors Service and Standard & Poor's assign the company high-
risk, high-yield ratings of Ba2 and BB-, respectively.

``The earnings showed that Softbank's risk is equivalent to
a BBB rating,'' Ohashi said. ``People paid too much of a premium
to compensate for Softbank's risk.''

Shares of Softbank yesterday fell the most in almost two
months as UBS Securities Japan Ltd. recommended selling the stock
after fourth-quarter net income slid 83 percent. The shares,
which declined 3.2 percent yesterday, dropped another 0.8 percent
today to 2,595 yen.

Excluding gains from the former Vodafone subsidiary,
operating profit would have declined, UBS analysts Makio Inui and
Kei Takahashi wrote in the May 8 report. The focus on the mobile-
phone unit ``led to some stagnation'' in other businesses such as
fixed lines, the analysts said.

Softbank has the worst financial health in Japan among 129
companies tracked by Morgan Stanley, credit-default swaps show.
The company said it booked taxes of 60.4 billion yen, partly
because of goodwill relating to the Vodafone purchase.

`Good Overall'

The telecommunications group is betting it can add to its 17
percent share of Japan's $75 billion mobile-phone market by
offering lower subscription fees than rivals. Growth in the
number of subscribers, which rose a net 163,600 to 16.1 million
in April, may help the company offset declines in per-user
revenue.

The chance of Softbank failing to meet its debt obligations
within the next five years has declined to 21 percent from 28
percent last year, based on a JPMorgan Chase & Co. valuation
model that takes into account swap prices.

``Softbank's earnings looked good overall,'' said Kiyotoshi
Yasuda, chief risk manager of the credit trading department at
JPMorgan Securities Japan Co. in Tokyo. ``Softbank credit-default
swaps showed little reaction to the announcement because the
market has already priced in an increase in sales.''

Credit-default swaps are the fastest-growing part of the
$370 trillion global derivatives market. They allow investors to
speculate on shifts in a company's credit quality without paying
money up front, as would be required when buying bonds.

To contact the reporters on this story:
Keiko Ujikane in Tokyo at

Oliver Biggadike in Tokyo at
.