JGB futures plunge on Treasuries, 5-yr auction eyed

By Rika Otsuka

TOKYO, May 14 (Reuters) - Japanese government bond futures plunged to a seven-month low on Wednesday, dragged down by an overnight fall in U.S. Treasuries, while investors nervously awaited Thursday's auction of recently battered five-year notes.

Treasuries fell on Tuesday after retail sales hinted that U.S. economic weakness might be less pronounced than some had thought, and after Federal Reserve officials sounded reluctant to cut interest rates further. [US/]

"The initial drop in JGB futures was due to losses in Treasuries," said Tatsuo Ichikawa, fixed-income strategist at ABN AMRO Securities. "But after that, futures could be pressured by hedge-selling against the five-year auction."

June 10-year JGB futures dropped as much as 1.83 points on the day to 134.28, their lowest since mid-October before recovering a tad to 134.44 2JGBv1, down 1.67 points.

The benchmark 10-year yield jumped 11.5 basis points to a seven-month high of 1.695 percent JP10YTN=JBTC.

Despite the sell-off, many market participants do not expect JGBs to extend losses sharply as the Bank of Japan is unlikely to raise interest rates from the current 0.5 percent soon. The central bank dropped its bias towards raising rates last month.

In addition, investors need to pick up bonds to replace many JGBs scheduled to be redeemed next month, analysts said. JGBs with durations of five years or longer mature in March, June, September and December.

"JGB yields have risen to attractive levels," said a senior portfolio manager at a Japanese life insurance company. "The market is likely to bottom out sooner or later as investors will start buying. Nobody is expecting the benchmark yield to rise to 2 percent."

At the same time, few investors are in a hurry to pick up JGBs as domestic stocks have recovered in the past two months, and global inflation concerns persist, the portfolio manager said.

Government data showed on Wednesday that Japan's annual wholesale inflation in April rose 3.7 percent from a year earlier, a little more than expected and rekindling worries that higher oil and other raw material prices could take a toll on the country's economic growth. JPCGPY=ECI

In late April, JGB futures posted their biggest one-day drop in five years as expectations for a BOJ interest rate cut receded, with some investors shifting their sights to an eventual rate rise.

The Finance Ministry's five-year debt sale on Thursday is seen as an important gauge of investor demand after the sell-offs in the past two months. Japanese banks, historically the main investors in the mid-term sector, have dumped five-year notes aggressively as they were badly burnt by the bond slump.

The five-year yield hit a nine-month high of 1.300 percent JP5YTN=JBTC, up 12 basis points.

The two-year yield was up 6.5 basis points at 0.820 percent JP2YTN=JBTC, while the 20-year yield climbed 5.5 basis points to 2.235 percent JP20YTN=JBTC. (Editing by Brent Kininmont)