Japanese government bonds fell sharply on Friday, a day after the European Central Bank shocked markets by saying it may raise interest rates as soon as July, hitting US Treasuries and euro zone bonds.
After a recent sell-off pushed 10-year yields to a 10-month high, JGBs had gained some reprieve this week on worries about credit-market related losses at major financial institutions and domestic investor buying of cash bonds. But the positive mood was erased after European Central Bank President Jean-Claude Trichet said on Thursday interest rates may go up next month.
"Trichet spoiled all of that," said Kazuhiko Sano, chief fixed income strategist for Nikko Citigroup in Tokyo. The ECB chief dropped a clear hint that rates could go up next month, saying that a quarter of a percentage point rise was "possible" although not "certain".
Market players said Trichet's remarks, which came on the heels of comments by US Federal Reserve Chairman Ben Bernanke this week that rising long-term inflation expectations were a "significant concern", stirred jitters that the Bank of Japan might raise interest rates sooner rather than later. June 10-year JGB futures fell 0.88 point to 134.35 edging back towards a 10-month low of 133.54 hit on Monday. Turnover was moderate around 41,600 contracts.
Bonds were also dragged lower as Tokyo's Nikkei share average climbed 1 percent. JGBs remained volatile and futures dropped by as much 1.35 point on Friday, just three days after they closed 1.43 point higher to match their biggest one-day rise in five years. The benchmark 10-year JGB yield rose 7 basis points to 1.795 percent, nearing a 10-month high of 1.805 percent hit last week.
Some traders said June JGB futures could draw some support in the days ahead from buybacks ahead of an imminent benchmark shift to the September contract. But with investors cautious to commit funds to bonds after being roiled by heavy selling over the past two months, market sentiment looks weak overall, market players said.
Ten-year yields could rise to 2.0 percent or higher in the next month, said Nikko Citigroup's Sano. Swap contracts on the overnight call rate showed that investors see a roughly 20 percent chance of the Bank of Japan raising interest rates from the current 0.50 percent by September, up slightly from around 15 percent on Thursday. The derivatives contracts show that investors widely expect the BoJ to raise interest rates by 0.25 percentage point to 0.75 percent within the next year.
The lead three-month euroyen futures contract dropped by as much as 10.5 basis points to 98.855 Investors are closely watching Friday's US jobs data, as it could further shape the market's monetary policy expectations. "If the payroll data turns out to be strong, it will boost rate hike expectations in the United States as well," said Hidenori Suezawa, chief fixed income strategist at Daiwa Securities SMBC. "The ECB has already suggested it may raise rates and this would be a potentially volatile combination," he said.