Finance and Economic

If Japan’s experience is any guide, the historic plunge in U.S. Treasury yields may deepen as the Federal Reserve’s moves toward unconventional policy tools — such as outright purchases of government bonds — to revive the economy.

As part of the Bank of Japan’s quantitative easing policy launched in March 2001 to fight against deflation, the central bank began buying government outright to drag down long-term rates after having already driven short-term rates to zero.

Benchmark 10-year Treasury yields may test all-time lows struck in the 1940s near 1.60 percent if the Fed decides to start scooping up government bonds as part of any new policy, a prospect Fed Chairman Ben Bernanke has raised.

The Fed is widely expected to cut rates to 0.5 percent or lower this week and possibly lay out new initiatives on top of its array of interventions to prop up frozen markets for commercial paper, mortgage and asset-backed securities.

U.S. banks and Wall Street financial firms are already following a similar pattern seen in Japan that is reinforcing the drop in Treasury yields.

Japanese commercial banks, which were badly hurt by the bursting bubble in stock and real estate prices, turned into hefty buyers of government bonds while repairing their balance sheets and cutting back on traditional lending.

“After the injection of public funds into Japanese major banks in 1999, domestic bank holdings of JGBs kept rising until 2004 or 2005,” said Kazuhiko Sano, chief fixed-income strategist at Nikko Citigroup direct payday loan lenders. “Their behavior may give hints on the future actions of U.S. banks.”

Data from the Fed shows that commercial bank holdings of Treasuries and agencies have surged and reached a record $1.284 trillion in October.

But those holdings of Treasuries and agencies make up just 10 percent of their $12 trillion in total assets, near the lowest proportion in the past 30 years.

In Japan, bank holdings of government bonds are still 36 percent of total assets, up from 9 percent in 2000.

BACK TO THE FUTURE

The 10-year Treasury yield fell as low as 2.48 percent last week, the lowest since 1954, and remain at just 2.58 percent.

Despite concerns about heavy Treasury debt issuance to pay for more fiscal stimulus and the next tranche of the Treasury’s $700 billion TARP program, yields will likely tumble if the Fed chooses to buy big amounts of long-term bonds, analysts said.

The BOJ’s purchases, starting at 400 billion yen ($4.3 billion) a month, drove 10-year yields down to a low of 1.02 percent at the time they were announced.

When the BOJ boosted monthly JGB purchases to 1.2 trillion yen in October 2002, within the next year the 10-year yield slid to just 0.430 percent in 2003 — the lowest benchmark government bond yield in history. 

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