Japanese government bond futures punched to a 22-month high on Friday as stocks were on the ropes again due to ongoing credit market troubles, adding to doubts about when the Bank of Japan can next lift interest rates.
Bond investors are giving up hope that yields will rise much in the fiscal year to next March and are starting to shift funds into the market, pushing the benchmark 10-year yield further below the psychologically key 1.50 percent level.
BOJ Deputy Governor Toshiro Muto highlighted the central bank's caution in an interview with Bloomberg, saying the US housing recession and financial market turmoil could hurt Japan's economy and make a decision to raise rates difficult.
The comments come after BOJ Governor Toshihiko Fukui said in a speech late on Thursday that the US housing problems were a risk to global growth.
Minutes from the BOJ's mid-October meeting also showed most board members felt the downside risks to the US economy were heightening. The BOJ kept rates on hold at 0.5 percent at that meeting and in two subsequent meetings, including one this week.
"The JGB rally is probably entering into an overshoot zone, but this situation is not going to change soon. We have to look at the US economic outlook," said Tomoko Fujii, senior economist and strategist at Bank of America. "The risk aversion means JGBs should be favoured." December 10-year futures rose 0.19 point to 137.04 and jumped as high as 137.31, the highest since January 2006.
The benchmark 10-year yield fell 2.5 basis points to 1.470 percent and touched a 22-month low of 1.460 percent earlier in the day.
The Nikkei share average fell 1.6 percent on Friday after slumping more than 2 percent at one point. The benchmark is down nearly 14 percent so far this year, one of the worst performers among the world's major stock markets. The sell-off in Wall Street shares and mounting expectations for further Federal Reserve rate cuts boosted Treasuries, with the US 10-year yield hitting a two-year low of 4.1365 percent in Asian trade.
"If Japanese banks, which had reduced their JGB holdings during the summer to prepare for an expected BOJ rate hike, decide to buy back the bonds aggressively, we are likely to see another round of falling JGB yields," said a senior bond dealer at a big Japanese bank.
The two-year JGB yield fell a basis point to 0.735 percent and struck a nine-month low of 0.715 percent, further below the BOJ's 0.75 percent Lombard rate for direct lending to banks.
The drop in the two-year yield to just 23 basis points above the overnight call rate target shows that many investors see the BOJ waiting until well into 2008 before lifting rates.
Swap contracts on the overnight call rate do not fully price in a rate hike to 0.75 percent until late next year. The contracts show about a 30 percent chance of a rate hike at the end of the fiscal year in March.
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