Japanese government bond futures jumped to a four-month high on Friday after a sharp rally in US Treasuries and on concerns about the outlook for the domestic and overseas economies. JGBs rallied broadly with yields on two-year, 10-year, 20-year and 30-year JGBs dropping to four-month lows, while the lead three-month euroyen futures marched to a four-month high.
Apart from the Treasuries rally, JGBs gained after European Central Bank President Jean-Claude Trichet's comments on Thursday reinforced expectations that the ECB was unlikely to raise interest rates this year, said Maki Shimizu, a strategist for UBS Securities. "That helped to underscore the fact that the main theme is the downturn in the economy," Shimizu said.
September 10-year JGB futures rose as high as 137.80 in the daytime session, hitting a four-month peak for the third straight day. JGB futures ended the session up 0.57 point at 137.68.
The 10-year JGB yield fell 4.5 basis points to 1.470 percent the lowest in four months. The 20-year JGB also hit a four-month low of 2.095 percent and the 30-year yield hit 2.310 percent the lowest since late March. "With a turn for the worse in global economic conditions, investors have no choice but to buy," said a dealer at a Japanese bank.
Long maturity US Treasury bonds rallied sharply on Thursday as a deteriorating job market, easing inflation concerns and a very strong 30-year bond auction propelled prices higher.
The European Central Bank left interest rates unchanged on Thursday and insisted inflation was still its key fear even though risks to growth were taking hold, prompting markets to scrap bets on rates rising again this year. Short-term yields, which tend to most strongly reflect shifts in the outlook for monetary policy, declined as well.
The two-year yield fell to a four-month low of 0.670 percent It later pulled up to 0.695 percent, still down 2.5 basis points on the day. The lead three-month euroyen futures contract jumped to a four-month high of 99.240 They later pulled back to 99.225 for a gain of 3.5 basis points on the day. Short-covering by overseas investors may have helped to exacerbate the rally in euroyen futures, said a senior trader for a major Japanese bank.
"Euroyen futures approached levels that could be seen as pointing to some expectations for a rate cut. But no one thinks there will be a rate cut and that's why they ran into some selling," the trader said.
JGBs are unlikely to fall sharply below 1.5 percent at this juncture, said Shimizu at UBS Securities, adding that the market would have to start to strongly factor in the possibility of a Bank of Japan rate cut for that to happen.
Swap contracts on the overnight call rate suggest investors still expect the next BoJ move will be a rate rise from the current 0.50 percent, although they see only about a 5 percent chance of such a move by the end of the current fiscal year to next March.
JGBs have rallied over the past couple of weeks as data pointed towards a downturn in Japan's economy and bolstered market expectations that the BoJ would keep interest rates on hold for a while.
The Japanese government cut its view on the economy in its monthly report on Thursday, dropping the word "recovery" for the first time in nearly five years, as high raw material costs and a global slowdown push the world's No 2 economy towards a recession.
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