Japanese government bond futures rose to their highest this year on Tuesday after the Ministry of Finance's five-year note auction showed strong investor demand for government debt. JGBs fell in early trade as investors trimmed holdings of cash bonds to make room on their books ahead of Tuesday's auction, while dealers sold futures to hedge against the debt sale.
But the market turned around after the auction attracted bids 3.64 times the offer, its highest since the November issue, despite the fact that it was a second re-opening of the No 87 issue and investors already hold large amounts of the paper. The MOF sold 2.4 trillion yen ($26.6 billion) of the current five-year note with 0.5 percent coupon on Tuesday, creating the largest single JGB issue to date.
"Investors demand is there for shorter-dated bonds such as five-year notes," said a bond trader at a European brokerage. "Investors expect the Bank of Japan's next monetary policy step will be easing, given rising pressure from the government to combat deflation." Finance Minister Naoto Kan told the lower house budget committee on Tuesday he would like to see price rises of 1 percent and urged the BOJ to cooperate in deating deflation.
BOJ Governor Masaaki Shirakawa said the central bank is willing to cooperate but it cannot end deflation on its own. Although Kan's comments did little to change expectations that the BOJ will stand pat at a two-day meeting ending on Thursday, investors will look for any hints of future policy easing when Shirakawa appears at a news conference afterwards.
Data released on Monday showed Japan's economy grew a stronger-than-expected 1.1 percent in October-December from the previous quarter, but the GDP deflator posted its biggest annual fall on record and pointed to lingering deflation. March futures rose 0.09 point to 139.70 after climbing as high as 139.76, their highest since December 30. The lead futures contract is likely in the near term to try the 140 level, a key psychological and technical resistance point, traders said.
The benchmark 10-year yield was unchanged on the day at 1.320 percent after rising as high as 1.335 percent earlier in the day. The five-year yield edged down 0.5 basis point to 0.505 percent, after slipping to 0.500 percent, while the 20-year yield inched up 1 basis point to 2.170 percent, a three- month high.
The 5-year/20-year yield spread widened to 167 basis points at one stage, its steepest in a decade according to historical data on Reuters EcoWin. Market players said the yield curve had steepened as expectations the BOJ could further ease monetary policy pinned shorter-dated yields at low levels, while life-insurers - the main buyers of the 20-year bonds - have come to prefer 30-year bonds that better match their asset-liability management needs.
"The steepening is near an end as the five-year yield is unlikely to slip further unless expectations for policy easing become more solid," said Chotaro Morita, chief fixed-income strategist at Barclays Capital. Also, life insurers are expected to pick up 20-year bonds when their yields rises to 2.2 percent, he said.