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September 21, 2017

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JPMorgan Chase to start yen inflation swap trading in Japan

TOKYO -- JPMorgan Chase & Co. hired Takuma Kitajima from Merrill Lynch & Co. to start trading yen inflation swaps as Japan emerges from a decade-long bout of deflation.

Consumer prices in the world's second-biggest economy rose at the fastest pace since 1998 in March as gas stations and grocers increased prices to compensate for rising fuel and food costs. Kitajima worked on Japan's first inflation swaps in 2004 at BNP Paribas SA. The contracts are used to prevent rising prices from eroding the value of the fixed payments from debt.

"Inflation will become more of a concern in one or two quarters," Kitajima said in an interview Thursday. "By that time there will be increasing demand for inflation-linked bonds and inflation swaps."

Inflation is returning as a threat to global economic stability because of a surge in commodity prices and a decline in the dollar, John Lipsky, the International Monetary Fund's deputy chief, said in New York Thursday. The European Central Bank kept its key interest rate at a six-year high of 4 percent Wednesday and said price increases will probably "remain high for a rather protracted period."

The 10-year inflation swap traded Friday at 40 basis points, said Gus Sekhon, an inflation-swap trader at Royal Bank of Scotland Plc in Tokyo. The Edinburgh-based financial institution won Risk magazine's award for inflation-derivatives house of the year in January. RBS trades about 25 billion yen (US$243 million) in inflation swaps each month, Sekhon estimated.

JPMorgan will start trading inflation-protected bonds in June and inflation swaps a month later, Kitajima said. A basis point is 0.01 percentage point.

Japanese consumer prices excluding fresh food rose at an annual 1.2 percent rate in March, accelerating from 1 percent a month earlier, a government report on April 25 showed.

The pickup in inflation led to the biggest one-day increase in Japan's five-year bond yields since 1999.

Inflation erodes the purchasing power of the fixed payments from debt, prompting investors to demand compensation in the form of higher yields from government and corporate borrowers.

"I'm basically an optimist for the inflation market," said Koji Shimamoto, chief strategist at BNP Paribas Securities Japan Ltd. in Tokyo and the nation's top government debt analyst in a Nikkei Veritas survey. "It's a very useful product."

Japan's inflation rate will probably average 1.5 percent over the next decade as the number of retirees increases, boosting consumption and health-care spending, and as the government more than doubles the sales tax from 5 percent, Shimamoto said.

In an inflation swap, one party agrees to pay a fixed rate on a notional sum to another in exchange for receiving the inflation rate. The contract will increase in value as inflation accelerates, pushing up the amount the investor receives. The contracts can also be used to speculate that inflation will slow.

Growth in the market may be tempered as domestic investors hold back from using the contracts out of concern trading isn't frequent enough to prevent price swings.

Investors outside Japan make up the bulk of the market for the government's inflation-protected bonds, said Maki Shimizu, a fixed-income analyst at UBS Securities Japan Ltd. in Tokyo.

"As long as foreigners are the major investors, sharp volatility is the risk," she said. "A shortage of liquidity is the main problem here."

The Japanese government started selling inflation-linked bonds in 2004 and starts a new benchmark every two to four months. The amount of notes outstanding rose to 8.4 trillion yen at the end of March, or 1.5 percent of the 546.7 trillion yen total of bonds outstanding, Ministry of Finance data shows.

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