JGBs inch up in tight range, stock moves eyed

By Chikako Mogi

TOKYO, May 28 (Reuters) - Japanese government bonds edged higher on Wednesday as losses in Tokyo shares prompted investors to look for bargains, but sentiment remained weak after a drop in U.S. Treasuries on inflation concerns.

The market erased earlier losses when the benchmark 10-year JGB yield matched its highest level in nearly 10 months, while the five-year yield also rose to the highest in almost 10 months.

The five-year maturity has been underperforming the rest of the curve as banks, major holders of medium-term notes, shed more of their bond holdings built up during the worst of the credit crisis to cut losses they made when JGBs were pummeled.

"The five-year yield hovering well above 1.3 percent finally spurred dip buying, as current market levels are attractive for those looking at absolute yield levels to make investment decisions," said Atsushi Ito, JGB strategist at Morgan Stanley.

"But the market lacks a clear sense of direction. Inflation worries prevent investors from aggressively buying bonds, while they are wary of pushing yields too high given the view that the Bank of Japan won't raise interest rates for a while."

The recent sell-off in the JGB market was partly driven by growing concerns about rising inflation pressures in Japan after years of deflation.

Oil fell $4 to $128 a barrel on Tuesday, pulled down by a stronger dollar and concerns that moves to cut Asian fuel subsidies could hurt demand. Treasuries fell after U.S. consumers' inflation expectations surged.

June 10-year futures 2JGBv1 fell as low as 133.99, just above a nine-month trough of 133.93 hit on Friday. They bounced back to as high as 134.56, before ending the morning session down 0.05 point at 134.30.

The benchmark 10-year yield JP10YTN=JBTC eased 0.5 basis point to 1.755 percent, after rising to 1.785 percent to match Tuesday's peak and the highest level since Aug. 9, 2007.

The five-year yield JP5YTN=JBTC fell 2 basis points to 1.315 percent after earlier rising to 1.360 percent, also the highest since Aug. 9.

Volume remained thin, exacerbating price movements as investors largely stayed on the sidelines.

"There is little buying interest from investors who had been hit hard by the recent sell-offs," said Naomi Hasegawa, senior JGB strategist at Mitsubishi UFJ Securities. "The absence of buyers who normally buy when yields reach certain levels will likely put upward pressure on medium- and 10-year yields."

The two-year yield JP2YTN=JBTC hit a seven-month high of 0.860 percent, up 1 basis point on the day.

Some traders said caution before a two-year note auction on Thursday could be weighing on the bonds.

The Ministry of Finance will offer 1.7 trillion yen ($16 billion) in two-year JGBs. Traders said the coupon could be set at 0.9 percent, up from 0.7 percent at last month's sale of the maturity. A 0.9 percent coupon would be the highest since an October issue of the maturity.