* 5-yr yield moves away from previous session's two-year high * 10-yr futures end higher after biggest 4-day drop since Oct 2008 By Lisa Twaronite TOKYO, May 16 Japanese government bond prices rose on Thursday after a four-session rout, finding solace in higher U.S. Treasuries and solid demand at this session's five-year sale. An overnight drop in U.S. bond yields for the first time in a week underpinned JGBs, market participants said. Treasuries had sold off on growing expectations that the Federal Reserve could taper its bond buying programme, but downbeat U.S. manufacturing data on Wednesday made that possibility appear less likely. Still, Thursday's calm belied the market turmoil that has followed the Bank of Japan's monetary policy overhaul last month. Investors are reevaluating some of their assumptions that Japanese prices and growth would remain at low levels, which has led some of them to reduce their JGB holdings. "The market might be calm for today, but volatile conditions will likely remain for a while," said Tomohiro Miyasaka, a fixed-income analyst at Credit Suisse Securities. The JGB market shrugged off data released early on Thursday that showed Japan's economy grew faster than expected in the January-March quarter, although corporate investment has yet to pick up to ensure a sustained economic upturn. The capital spending figures in the GDP report weighed on Japanese shares, with the Nikkei share average falling from a 5-1/2-year high hit on Wednesday. Weaker shares also helped underpin sentiment for bonds. The yield on the 10-year cash bonds fell 3 basis points to 0.840 percent after dropping as low as 0.825 percent. It moved away from 0.920 percent hit on Wednesday, which was its highest level in over a year. The 10-year JGB futures contract ended up 0.38 point at 142.27 after rising as high as 142.56. Futures marked their biggest four-day fall since October 2008 through Wednesday, during which they shed 2.87 point. On Wednesday, the Bank of Japan offer to inject 2.8 trillion yen in market operations, about three times its usual amount, in a move that was "a response to sharp rises in longer-term interest rates," according to an official with the BOJ's Financial Markets Department. Japanese Finance Minister Taro Aso said on Thursday Japan must be prepared to see JGB yields rise once money starts to circulate through the economy to a certain extent, and that it needed to pay close attention to movements in yields, Jiji news agency reported. "It is very difficult to assess this market, which is still adjusting to the Bank of Japan's new monetary policy, and hard to figure out where fair value is," said a fixed-income fund manager at a European asset management firm in Tokyo. The Ministry of Finance offered 2.7 trillion yen ($26.36 billion) in five-year notes with a coupon of 0.4 percent, above the 0.3 percent coupon on the issue offered at last month's sale and far above the 0.1 percent coupon at the sale before that. The notes sold at a lowest price of 99.96, in line with market expectations, and attracted bids of 3.39 times the amount offered, up from the previous sale's bid-to-cover ratio of 3.09 times. The tail between the average and lowest accepted prices shrank to 0.02 from 0.05 at last month's offering, indicating solid demand. The five-year bond extended gains after the results were announced, its yield losing 3 basis points to 0.390 percent after falling as low as 0.385 percent. Five-year yields hit a two-year high of 0.455 percent touched on Wednesday as banks in particular unloaded their holdings in that sector. Japan's top three banks forecast weaker annual earnings on Wednesday, as the BOJ's aggressive monetary easing squeezes them out of a what had been profitable trade in JGBs. Some global markets have been bracing for a flood of Japanese cash, as institutions turn to overseas debt in the wake of the central bank's move, but so far outflows have been subdued. Weekly capital flow data released on Thursday by the Ministry of Finance showed that Japanese investors slowed the pace of their overseas bond purchases in the week through May 11 to a net 186.4 billion yen from 301.2 billion yen the previous week.
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