JGBs gain as Nikkei falters, banks buy debt on dips

TOKYO May 20 (Reuters) - Japanese government bond futures pushed higher on Tuesday, getting a slight boost as market players covered short positions on a drop in stocks and gains in U.S. Treasuries.

Strength in medium-sector cash bonds added some late gains to the futures as Japanese banks returned to the market to buy the five-year notes on dips, analysts said.

"A domestic investor bought medium-sector JGBs just as the market is testing how solid the rebound since the start of the week would be," said Keiko Onogi, a senior JGB strategist at Daiwa Securities SMBC.

JGB futures have bounced back from seven-month lows hit last week but remain susceptible to sharp moves as weeks of severe volatility have burned many players ranging from big Japanese banks to foreign hedge funds, prompting them to pull back from the market.

Comments by Bank of Japan Governor Masaaki Shirakawa had little impact on the market as they matched expectations that the central bank will sit tight for some months before eventually raising rates.

At his post-meeting news conference, Shirakawa said he was still focusing on downside risks to the nation's economy, as he explained last month.[ID:nTKU003285]

"Shirakawa's comments indicate that the BOJ's monetary policy stance remains neutral, giving little incentive for the market to move," said Tomohiko Katsu, a senior manager in the treasury division at Shinsei Bank.

Earlier, the BOJ's policy board voted unanimously to keep interest rates at 0.5 percent, as widely expected, as the central bank wrapped up a two-day meeting.

June 10-year futures 2JGBv1 rose as high as 135.69 1JGBM8 in the evening session, after ending the regular session at 135.47, up 0.35 point on the day. The lead contract pulled further away from a seven-month low of 134.28 hit last week.

Reflecting the big moves, historical volatility in the lead futures contract over the past month is holding near its highest levels since the market's big sell-off in 2003.

Analysts said trend-following CTA accounts appear to have been among the notable participants to abandon trading in JGB futures, contributing to the drop in open interest and leaving the market vulnerable to more volatility.

Open interest in lead futures fell 1,640 to 96,049 as of Monday, near the three-year low of 90,539 hit last week.

The benchmark 10-year yield JP10YTN=JBTC dipped 2.5 basis points to 1.645 percent, retreating further from a seven-month high of 1.710 percent hit on Friday.

The five-year yield JP5YTN=JBTC fell 4.5 basis points to 1.200 percent, well off a nine-month high of 1.320 percent struck last week.

The two-year yield JP2YTN=JBTC edged down 2 basis points to 0.805 percent.

The JGB gains came as the Nikkei share average .N225 shed 1 percent at one stage, retreating from a four-month peak struck last week. [.T] It ended the day down 0.77 percent.

Swap contracts on the overnight call rate JPONIBOJ=TRDT shows a roughly 60 percent chance of a quarter-point rate hike by the end of the year, unchanged after Shirakawa's remarks.

Some traders said the interest rate derivative market might have been exaggerating the chance of a BOJ rate hike and reflected more the sell-offs in short- and medium-term sectors last week.

At its policy meeting about three weeks ago, the central bank dropped a two-year bias towards raising rates and took a neutral stance on monetary policy, saying it was inappropriate to predetermine its policy direction given high uncertainty. (Additional Reporting by Eric Burroughs and Takaya Yamaguchi, Editing by Michael Watson)