Japanese government bond futures surged to a six-week high on Monday, extending gains after weak machinery orders data last week strengthened concerns that the economy may have hit a soft patch in the third quarter.
Strong momentum to buy JGBs spilled over from Friday when the surprise drop in machinery orders helped reinforce market expectations that the Bank of Japan would wait until next year to raise interest rates again.
The figures have cranked up speculation that growth data for the July-September period due on Tuesday could come in weaker than market expectations, further suggesting that the economy may not be as firm as originally thought. "Before, the market was debating whether the economy was still firm or whether it was slowing down," said an analyst at a US securities firm.
"But over the past month, the people who have been betting on the 'slowdown' scenario seem to be winning out." A gain in US Treasuries on Friday and slide in the Nikkei share average to a six-week low on Monday also boosted market sentiment, analysts said. December 10-year JGB futures ended up 0.28 point at 135.08, after peaking at 135.15, the highest since late September.
The benchmark 10-year JGB yield fell 2.5 basis points to a six-week low of 1.655 percent, while the two-year yield slipped by the same amount to 0.730 percent. This put the spread between the two maturities at 92.5 basis points, around its lowest level since August 2003 hit on Friday and keeping the yield curve flattening trend intact.
The five-year yield fell 3.5 basis points to a one-month low of 1.155 percent. The 20-year yield fell 1.0 basis point to 2.125 percent, matching a level last seen in late September. Data on Friday showed that Japan's core private-sector machinery orders, a key gauge of corporate capital spending, fell 7.4 percent in September from August, well below forecasts for a rise of 1.9 percent.
That data not only reduced expectations for a year-end rate hike but reinforced market scepticism over the BOJ's positive outlook for the economy, traders and analysts said. Tuesday's data is expected to show that GDP grew 0.2 percent in price-adjusted terms in July-September from the previous quarter, giving an annualised growth reading of 1.0 percent.
JGBs could rally further if the data shows that the economy contracted in the July-September quarter, analysts said. "There is a high possibility that a 'GDP shock' similar to the 'CPI shock' will occur if the data confirms that the household sector is sluggish, and comes in negative as a whole," Kazuhiko Sano, chief strategist for Nikko Citigroup Ltd, said in a research note.
"In that case, the 10-year JGB yield will likely fall to 1.600 percent," Sano said. JGBs had staged a furious rally from late August to early September, after Japan's consumer price data under a new calculation method came in much softer than expected.
The so-called "CPI shock" pushed the 10-year JGB yield down to what was then a six-month low of 1.600 percent on September 1. Another key event coming up on Tuesday is an auction of 2.0 trillion yen in five-year JGBs. Based on current market levels, the coupon is likely to be left unchanged from last month's auction at 1.2 percent and there will likely be a re-opening of the October issue, analysts said.
Such a level may be too low to stir significant buying interest among investors, given the possibility that the BOJ may raise rates early next year, analysts said. Three-month euroyen futures for March expiry rose 1.5 basis points to 99.315, indicating a three-month interbank rate of 0.685 percent by then, versus about 0.458 percent now and reflecting the risk that rates will rise in the January-March period.
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