Japanese government bonds surged on Friday, with the benchmark 10-year yield dropping sharply from a seven-month high as investors rushed to buy paper at higher yield levels after putting a poor 10-year debt sale behind them.
Roiled by a steep sell-off two weeks ago that sent JGB futures tumbling to their biggest one-day drop in five years, market players had been worried about the prospects for Thursday's auction of benchmark 10-year bonds.
But JGBs got a lift as investor bargain-hunting emerged following the weak auction, and the rally gained momentum on Friday, helped by a 2 percent drop in Tokyo share prices and overnight gains in US Treasuries.
Pension funds aggressively picked up 10-year bonds as well as recently battered five-year notes, while hedge funds bought futures, traders said. Short covering by dealers likely helped exacerbate the rise, they said.
JGB futures gave up some ground in the afternoon as investor buying ebbed once 10-year yields fell below 1.6 percent. "Investors are buying as they figured that bond yields had limited scope for a further rise after seeing the market hanging in there despite a weak auction," said Atsushi Ito, JGB strategist at Morgan Stanley.
"Today's rally gives the impression that investor bond buying is fairly strong," he said. June 10-year futures climbed by as much as 1.06 points to 136.86, but later trimmed gains to end the regular session at 136.60 up 0.80 point. The benchmark 10-year yield fell 8.5 basis points to 1.555 percent well off a seven-month high of 1.680 percent struck this week.
The five-year yield fell 6 basis points to 1.120 percent. The yield curve flattened as two-year yields fell by a comparatively mild 1.5 basis point to 0.725 percent.
CEILING FOR BONDS?
Further gains may be limited in the short-term as investors have not altered expectations for the Bank of Japan to eventually raise interest rates, although the central bank is seen likely to keep rates at 0.5 percent for a while.
"JGB yields will stay range-bound, overall, as long as the BOJ is expected to keep its neutral stance," said Hidenori Suezawa, chief fixed-income strategist at Daiwa Securities SMBC. The BOJ late last month dropped its bias towards raising rates and adopted a more neutral stance, saying that it will adjust rates flexibly.
"While there is a willingness to buy when 10-year yields are above 1.6 percent, there is a reluctance to buy at levels below that," said a portfolio manager for a Japanese regional bank.
"If 10-year yields were to drop below 1.5 percent, I think people will probably look to sell," he said, adding that one idea might be to sell call options on JGBs if that happens.
Swap contracts on the overnight call rate show investors see a roughly 35 percent chance of the BOJ boosting rates by the end ofnear term, said Junji Kojima, senior deputy manager for Sompo Japan Insurance Inc's global securities investment department.
"I think the sell-off in JGBs was over done," Kojima said, adding that 10-year JGBs could settle into a range roughly between 1.4 percent and 1.6 percent for the rest of the month.
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