JGBs fall as Fed acts on credit market strains

By Chikako Mogi

TOKYO, March 12 (Reuters) - Japanese government bond futures pulled back from a 2-½ year high on Wednesday after the Federal Reserve took steps to alleviate the strains in credit markets, boosting stocks and hurting safe-haven debt.

JGBs retreated along with Treasuries after the Fed announced a new facility for providing funds to banks and relaunched liquidity agreements with major foreign central banks after a sharp deterioration in the $7 trillion U.S. mortgage bond market.

The pull-back in JGBs also gave a reprieve to investors and hedge funds that have been battered in the past week by bad trades in the yen interest rate swap market and also in other securities such as inflation-linked bonds.

As hedge funds and other players, mostly foreign, rushed to unwind those trades, futures soared and yen swap spreads were driven to the widest levels on record.

Analysts said quick trimming of losses partly reflected moves by market players to unwind more of those bad positions.

"The Fed's action to ease the credit tightness gave some break to the unwinding moves, while spurring profit-taking in the short- to medium-term maturities which had been outperforming, helping to normalise swap spreads," said Koji Ochiai, a senior market analyst at Mizuho Securities.

"As foreign players took a break with some stability returning to the markets, trading was subdued as many Japanese investors stayed sidelined," partly because they tend to refrain from actively trading before the fiscal year-end book closings, he said.

With the rise in medium-term yields, the spread between two- and five-year yields was 20.5 basis points, holding near its flattest levels in five years. The spread between five- and 20-year yields shrank for a second day after having steepened to the most since October 2005.

The five-year yen swap spread JPYSB6L5Y= was quoted near 30 basis points, snapping back from as wide as 41 basis points the previous day.

June 10-year futures 2JGBv1 slipped 0.06 point to 139.44, recovering from an intraday low of 138.98. The lead contract reached a 2-1/2-year peak of 139.78 on Tuesday.

The benchmark 10-year yield JP10YTN=JBTC edged up half a basis point to 1.330 percent.

The two-year yield JP2YTN=JBTC climbed 2 basis points to 0.570 percent, while the five-year yield JP5YTN=JBTC was up 1 basis point at 0.775 percent.

In the U.S. swaps market, five-year spreads USD5YTS=RR collapsed about 15 basis points the previous day on the Fed's action, one of the biggest one-day moves ever.

The latest Fed efforts to contain the fallout from the U.S. subprime mortgage crisis gave a shot of confidence to investors, even as analysts said the relief would likely be temporary after the benefits of similar efforts in December proved short-lived. [ID:nL11474708]

"In my opinion, the Fed's action to widen the collateral to private mortgage-backed securities is more supportive as compared with a big rate cut or the Term Auction Facility. But the market has learned from past experience," said Makoto Yamashita, chief JGB strategist at Lehman Brothers.