JGB futures edge up from 9-mth lows, gains limited

By Eric Burroughs

TOKYO, May 26 (Reuters) - Japanese government bond futures clawed up on Monday from nine-month lows struck last week as a surge in Treasuries on worries about the U.S. economy and a drop in Tokyo shares helped temporarily stem the market's sell-off.

But gains were kept in check as many market players, especially big Japanese banks, are still looking to cut back on their holdings of JGBs built up during the credit crisis and as record oil prices have stirred worries about inflation.

JGB futures plunged more than a full point on Friday on more heavy selling by banks and other investors, with liquidity suffering from the sharp volatility of the past two months that has made other players unwilling to step in to buy.

Analysts said that JGBs were vulnerable to another such downdraft if more banks and investors move to sell at any cost.

The market is now waiting to see the results of the Bank of Japan's outright JGB buying operation on Monday. Those operations have become a source of selling over the past few weeks after dealers had difficulty unloading some paper to the central bank.

Investors are also bracing for the April consumer price data on Friday.

"Market sentiment is pretty bad," said Kenro Kawano, senior interest-rate strategist at Credit Suisse. "At least at the moment, it's a bear market."

But Kawano said the surge in oil prices and the jump in interest rates should ultimately hurt the Japanese economy, and if so that should cool some of the expectations for the BOJ to lift rates in the coming year.

June 10-year futures 2JGBv1 edged up 0.21 point to 134.56, up from the nine-month trough of 133.93 struck on Friday.

The benchmark 10-year yield JP10YTN=JBTC dipped half a basis point to 1.730 percent, off the nine-month peak of 1.755 percent reached on Friday.

The five-year yield JP5YTN=JBTC fell 1.5 basis points to 1.285 percent.

JGBs have been vulnerable as investors worried about the mounting inflation threat from surging oil prices, which hit a record high above $135 a barrel CLc1 last week.

The market has also been spooked by talk that one major JGB holder was shedding short-term paper, leaving bond dealers stuck with unwanted bonds they were trying to get rid of in the BOJ's regular "rinban" operations.

As a result, dealers have scrambled to sell those bonds into an already sliding market, several traders and fund managers said.

Domestic investors such as big Japanese banks have also rushed to cut holdings on the view that a further sell-off was likely.

Some big banks have also been paying fixed rates in the swaps market to reduce their portfolio exposures to a further spike in cash bond yields.

(Editing by Brent Kininmont)