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Lost amid government reports that China reduced its holdings of Treasuries by a record amount in December were data showing Japan increased its stake, a move that may signal U.S. yields are peaking.

Purchases by Fukoku Mutual Life Insurance Co., Mizuho Asset Management Co. and Daiwa SB Investments Ltd. helped push Japan’s holdings to $768.8 billion, an increase of $11.5 billion. U.S. government debt held by China fell $34.2 billion to $755.4 billion, Treasury Department figures showed Feb. 16.

Increased buying from a country that has lived through a decade of recessions and deflation indicates Treasuries are a relative bargain, with consumer prices in check and savings rates rising. Investors in Japan, where households have built up 1,400 trillion yen ($15 trillion) of financial assets, are attracted by U.S. yields that reached the highest since 2007 compared with Japanese government bonds.

“When the yield is high, people buy,” said Satoshi Okumoto, an investment manager in Tokyo for Fukoku, which oversees the equivalent of more than $60 billion. “The prospect for inflation is quite limited. Consumer demand is limited” in the U.S., he said.

The insurer bought as yields on 10-year Treasuries rose to 2.55 percentage points above those on similar-maturity Japanese bonds in December, the most in two years, he said. While the spread shrank to 2.46 percentage points today, it’s still about 40 basis points above the average in that period.

Japanese Demand

Demand from investors such as Mizuho Asset, Fukoku Mutual Life and Daiwa SB, which together oversee $118 billion, may help cap bond yields even as the biggest traders predict the U.S.’s ballooning supply of debt will drive rates to the highest since July 2008.

In a Bloomberg News survey at the end of 2009, Barclays Capital Inc., Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of the 18 primary dealers that trade directly with the Federal Reserve forecast the 10-year yield would rise to 4.14 percent in 2010, from 3.84 percent on Dec. 31.

“Employment is very fragile,” said Hiromasa Nakamura, a senior investor who helps oversee the equivalent of $21.1 billion in Tokyo at Mizuho, part of Japan’s second-largest bank by assets. “U.S. households will increase their savings. That’s negative for the economy and positive for bonds.”

Nakamura said the yield on the benchmark U.S. 10-year note will decline to 3 percent by June 30 from 3.80 percent today. Investors would earn 8 percent if Nakamura’s forecast is accurate, according to data compiled by Bloomberg.

U.S. Inflation

U.S. government reports show that the more than $8 trillion in monetary and fiscal stimulus has yet to spark inflation.

The Labor Department said on Feb. 19 that consumer prices rose 0.2 percent in January, and fell 0.1 percent when excluding food and energy. The core inflation rate rose 1.6 percent the past 12 months, below the average of 2.7 percent since the start of the 1990s.

While the economy expanded 5.7 percent in the fourth quarter, consumer borrowing declined in December for an 11th- straight month, the longest on record, according to a Fed report released Feb. 5. The Labor Department said the same day the economy lost almost a million more jobs in the 12 months ended in March 2009 than it had previously estimated.

‘Subdued’ Inflation

“Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit,” the U.S. Federal Open Market Committee said after its last meeting on Jan. 27. “Inflation is likely to be subdued for some time.”

The U.S. savings rate has increased to 4.8 percent from 0.8 percent in 2005, according to government reports. Similar to Japan, U.S. banks are funneling that cash into bonds.

U.S. financial institutions increased their holdings of Treasuries and the debt of government-backed mortgage companies such as Fannie Mae in Washington and McLean, Virginia-based Freddie Mac to $1.43 trillion this month from $1.1 trillion at the end of 2007, Fed data show.

That may help offset lower demand from China, whose Treasury holdings peaked at $801.5 billion in May. The nation reduced the amount of Treasuries in its $2.4 trillion of currency reserves after expressing concern about U.S. borrowing to fund a growing budget deficit.

China ‘Worried’

That was two months after Premier Wen Jiabao said he was “worried” about the holdings and wanted assurances that the nation’s U.S. investments were safe. Central bank Governor Zhou Xiaochuan proposed a global currency to reduce reliance on the dollar.

China may have allowed holdings of short-term bills to mature in December and replaced them with a smaller amount of longer-term notes and bonds, Treasury Department data show.

Kokusai Global Sovereign Open, Asia’s biggest bond fund, is shunning Treasuries because of the outlook for the dollar, said Masataka Horii, one of the portfolio managers. The $43.5 billion fund holds 18.6 percent of its assets in dollar-denominated bonds, about the lowest level since it started in 1997, he said.

“Because of low inflation, the Fed will keep its policy rate at a record low,” he said. “The dollar will be weak.”

The Fed raised the discount rate charged to banks for direct loans by a quarter point to 0.75 percent on Feb. 18, pushing the greenback to a one-month high against the yen. Policy makers said the move will encourage financial institutions to rely more on money markets rather than the central bank for short-term liquidity needs.

Dollar Fluctuations

The Fed will keep its target for overnight lending between banks, its main policy tool, near zero through 2010, Horii said.

Measured against a basket of currencies from the Group of 10 nations, weighted by how they trade against each other, the greenback is down about 16 percent from last year’s peak in March, according to Bloomberg Correlation-Weighted Currency Indexes. The index for the dollar rose 0.1 percent last week.

Relatively high U.S. yields may lure more of Japan’s savings, after the nation increased its holdings by $142.8 billion, or 23 percent, in 2009.

Financial Services Minister Shizuka Kamei said he is considering whether to invest funds from Japan Post Bank Co., the world’s largest holder of deposits, overseas. Japan Post had 195.7 trillion yen of assets as of Dec. 31, equivalent to $2.13 trillion, based on figures from the company’s Web site.

Room for Sales

Since Barack Obama became U.S. president in January 2009, Japan’s biggest bond investors have said he has room to increase debt sales without driving up borrowing costs as he tackles the worst economy since World War II.

One-month bill yields turned negative last month. Benchmark 10-year yields, while rising from their record low set in 2008, are still more than half a percentage point lower than the average over the past decade.

Obama increased the amount of U.S. marketable debt to $7.23 trillion last month from $5.75 trillion a year earlier. The budget deficit will swell to an unprecedented $1.6 trillion in the fiscal year ending Sept. 30, the Obama administration predicted Feb. 1.

Japan’s experience shows record debt sales don’t translate into higher bond yields as long as inflation is kept in check. Japan’s 10-year bond yield of 1.33 percent is the lowest of 31 nations tracked by Bloomberg.

Government debt in Japan is equivalent to $9.06 trillion, almost double the size of the nation’s annual gross domestic product. The U.S. debt is about half the size of its GDP.

Seeking ‘Safe Assets’

“Japan bonds lack appeal because yields are so low,” said Yuichi Onsen, chief strategist in Tokyo at T&D Asset Management, which oversees the equivalent of $18.5 billion and is a unit of Japan’s largest publicly traded life insurer. “There’s demand for U.S. bonds as safe assets.”

Treasuries are also drawing investors on concern that Greece will fail to reduce the European Union’s largest budget deficit, slowing growth, said Kei Katayama, leader of the foreign fixed-income group in Tokyo at Daiwa SB, part of Japan’s second-biggest brokerage. Greece’s budget crisis pushed the euro to a nine-month low on Feb. 19.

“U.S. assets may outperform European assets,” Katayama said. “Sovereign risk and falling confidence in the EU system are leading to a flight to quality.”

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