JGB futures slip near 10-month low, but market calms

By Eric Burroughs

TOKYO, May 30 (Reuters) - Japanese government bond futures dipped back near a 10-month low on Friday, but losses were limited after a batch of data showing a slowdown in consumer price inflation and rising unemployment.

Analysts also said longer-dated bonds were buoyed as pension funds and other passive investors were shifting funds into the sector to match changes in benchmark performance indexes before the end of the month.

JGBs have been battered for two months as growing confidence among investors that the worst of the credit crisis has passed spurred many investors to dump safe-haven debt holdings and brace for potential interest rate hikes.

Until the market starts to calm down some more, investors like big Japanese banks are likely going to shy away from commiting any funds to JGBs, analysts said.

"One of the reasons for the current sell-off is the high volatility. Due to high volatility, banks can't take risks. If yields stabilise, then volatility will stabilise," said Makoto Yamashita, chief JGB strategist at Lehman Brothers.

Yamashita said previous JGB sell-offs have typically lasted for about three months, so if that pattern holds, the current slide that began in mid-March could come to an end next month.

JGBs took a hit in evening trade on Thursday on the back of a slide in Bunds and Treasuries as investors across the world's top economies now see a chance of higher interest rates by the end of the year.

Yet analysts said Japanese data showing unemployment rising to a seven-month high, industrial output falling for a second straight month and household spending dropping underscored the Bank of Japan's caution on the outlook. [ID:nT227873]

Such caution should ultimately help cool expectations of future rates hikes, highlighted by the two-year JGB yield rising to a 10-month high of 0.915 percent -- 41.5 basis points above the BOJ's current 0.5 percent target for overnight rates.

June 10-year futures 2JGBv1 dipped 0.02 point to 134.08 but held above the 10-month trough of 133.77 struck in Thursday's evening session.

The benchmark 10-year yield JP10YTN=JBTC was down half a basis point at 1.785 percent, holding off a 10-month peak of 1.805 percent hit late on Thursday.

The two-year yield JP2YTN=JBTC rose 1 basis point to 0.915 percent. The 20-year yield JP20YTN=JBTC was also unchanged at 2.300 percent.

Any month-end buying by institutional investors was expected to have a bigger impact than usual on the market because liquidity remains so thin as many players have backed away from trading to avoid getting caught in the big daily swings. (Editing by Hugh Lawson)