Japanese government bonds tumbled on Friday and benchmark yields soared to a nine-month high as more investors slashed their exposure to debt, fretting that high market volatility would further damage their portfolios.
Futures fell more than a full point to extend the previous day's sharp slide as growing views that the Federal Reserve may have to raise interest rates to fight rising price pressures have hurt US Treasuries and given a knock-on hit to JGBs.
JGBs were vulnerable as investors worried about the mounting inflation threat from surging oil prices, which hit a record high above $135 a barrel this week. Steep energy costs have pushed Japan's core consumer prices up to the fastest annual pace in a decade.
"Finally, after 10-15 years, the inflation threat is here. This is something we haven't experienced in quite some time. It's an X factor. So people are very cautious about fixed-income overall," said Naruki Nakamura, a portfolio manager who oversees about 400 billion yen ($3.84 billion) in JGBs at Fischer Francis Trees & Watts.
The market has also been spooked by talk that one major JGB holder was shedding short-term paper in a way that left bond dealers stuck with unwanted bonds they were trying to get rid of in the Bank of Japan's regular "rinban" buying operations. As a result, dealers have scrambled to sell those bonds into an already sliding market, several traders and fund managers said.
Domestic investors such as big Japanese banks have also rushed to cut holdings on the view that a further sell-off was likely.
"The amount of risk that investors such as banks could take with their bond holdings decreased as the market breached new lows, probably prompting them to dump bonds," said a chief fund manager at a Japanese asset management firm.
June 10-year futures tumbled 1.07 points to 134.35 after having sunk as low as 133.93, a nine-month low. Volume was about 30 percent above the daily average this year.
From a technical standpoint, the lead futures contract now looks poised to potentially drop all the way down to the 2007 low of 130.76, which would mark a complete retracement of the rally from that low to the five-year high of 141.91 hit in March. The benchmark 10-year yield jumped 8.5 basis points to 1.740 percent, having reached a nine-month peak of 1.755 percent. Traders said some regional Japanese banks were among those spotted picking up bonds. The five-year yield the most sensitive to moves in futures, was up 9.5 basis points at 1.300 percent after hitting a nine-month high of 1.325 percent.
Some big banks were also paying fixed rates in the swaps market to reduce their portfolio exposures to a further spike in cash bond yields. That pushed the five-year yen swap spread to near 34 basis points, widening a sharp 11 basis points in just three days. The two-year yield rose 4 basis points to 0.830 percent, while the 20-year yield climbed 6 basis points to an 11-month high of 2.350 percent.
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