Japanese government bond futures fell on Monday, retreating from a two-month high as Tokyo shares rebounded from earlier losses and investors remained wary the Bank of Japan could raise interest rates as soon as August.
JGBs extended losses as investors took profits after concluding that bond yields have fallen too far if the BoJ decides to lift the overnight call rate to a 12-year high of 0.75 percent in August from the current 0.50 percent.
A global slide in equity and corporate bond markets in the past week has stirred doubts about a BoJ interest rate rise next month, and driven benchmark JGB yields to two-month lows.
"Bond prices eased in a reaction to their recent big rally," said Akihiko Yokoyama, a fixed-income strategist at J.P. Morgan Securities. "It would be impossible for JGB yields to stay at current levels if the BoJ boosts interest rates in August," Yokoyama said.
September 10-year JGB futures slid 0.21 point to 133.04, after climbing to a fresh two-month high of 133.30 in early trade. The benchmark 10-year yield rose 2.5 basis points to 1.805 percent on selling by investors who took profits after the yield fell as low as 1.775 percent, the lowest since early June.
The 20-year yield climbed 4 basis points to 2.215 percent, and the 30-year yield rose 4.5 basis points to 2.465 percent. The Nikkei share average was nearly flat but had at one stage been down more than 1 percent to hit a four-month low, following a defeat for Prime Minister Shinzo Abe's conservative ruling coalition in a Japanese upper house election on Sunday.
The five-year yield was up 2 basis points at 1.385 percent after matching a two-month trough of 1.365 percent first hit on Friday. The two-year yield rose 1.5 basis points to 0.985 percent, hovered near a two-month low of 0.970 percent touched late last week.
Lead March euroyen futures edged down a basis point to 98.945, pulling back from a one-month high of 98.965 as some dealers sold futures to hedge their positions ahead of an auction of 2-year JGB on Tuesday. Swap contracts on the overnight call rate showed a roughly 50 percent chance of a BoJ rate hike in August, steady from late last week.
"Investors are staying cool about the situation, with chances of an August rate hike by the BoJ remaining about 50 percent," said Tetsuya Miura, a bond strategist at Shinko Securities. The probability of a BoJ rate rise indicated by swap contracts has fallen from above 90 percent earlier in the month as bond investors have started to feel that turbulence in global markets may make the BoJ more cautious about raising interest rates.
Meanwhile, investors who had speculated in widening yen swap spreads following such moves overseas in the past week were closing such positions, dealers said. Ten-year yen swap spreads narrowed marginally to around 21 basis points from around 23/24 basis points late last week.
"They are lightening positions ahead of US jobs data later this week, which may impact overseas debt markets," said a senior yen swap trader at a Japanese bank. Spreads on US interest rate swaps had widened sharply last week on credit crunch fears triggered by the US subprime mortgage woes. Ten-year US swap spreads, the benchmark for credit spreads, had swelled to their widest levels in five years, beyond 70 basis points.
Market participants said the bond market reacted calmly to the defeat of Japan's ruling coalition Sunday's elections as the result had already been factored into bond prices. Japan's industrial production rose 1.2 percent in June from a month earlier, the first increase in four months, a sign that the economy's weakest link is recovering and meaning the BoJ could still be on track to raise rates.