JGBs surge after Treasuries rally, eyes on auction

By Masayuki Kitano

TOKYO, June 3 (Reuters) - Japanese government bond futures surged on Tuesday after U.S. Treasuries rallied the previous day on safe-haven buying due to renewed concerns about the health of the financial sector.

JGB futures rose on short-covering after sliding to 10-month lows on Monday, while the 10-year yield slid around 7 basis points and euroyen futures rallied around 5 basis points.

Recent optimism that a global credit crisis was winding down took a severe blow on Monday when Standard & Poor's cut debt ratings of three U.S. brokers, a top U.S. bank ousted its chief executive and a British lender offered a bleak assessment of the UK housing market. [ID:nN02565648]

"JGBs are taking cues from the flight-to-quality type moves seen in U.S. and European markets as concerns about the financial sector re-emerged," said Naomi Hasegawa, a senior fixed-income strategist for Mitsubishi UFJ Securities.

The rise in JGBs, however, could temper investor demand for a key 10-year bond auction later on Tuesday, by making the new 10-year bonds less attractive for investors who had been hoping to buy the bonds on dips, market players said.

June 10-year JGB futures rose 0.58 point to 134.50 2JGBv1, rebounding after sliding on Monday when they hit a 10-month low of 133.54.

The 292nd 10-year yield fell 6.5 basis points to 1.720 percent JP10YTN=JBTC, pulling away from a 10-month high of 1.805 percent hit last Thursday.

The lead March three-month euroyen futures contract rose 5 basis points to 98.885 JEYv1.

EYES ON AUCTION

The Ministry of Finance offered 1.9 trillion yen ($18.2 billion) of 293rd 10-year JGBs on Tuesday with a 1.8 percent coupon, up from 1.7 percent at the previous 10-year auction in May.

The 1.8 percent coupon rate was the highest since the 1.8 percent coupon at a 10-year JGB auction held last August, when turbulence in global credit markets had started to deepen.

While dealers looking to cover short positions were likely to buy the new bonds, investors were unlikely to take them up immediately, market players said.

"There probably aren't very many people who will actively take part in the auction, so it may be hard for JGBs to hold firm in the afternoon as they did this morning," said a portfolio manager for a Japanese insurer.

The JGB market has not recovered from the heavy selling over the past two months as investors shed government bonds built up while the global credit crisis deepened.

Players are also worried about the threat of mounting inflation pressures, and are keeping a close eye on overseas bond yields and potential interest rate hikes, including from the Bank of Japan.

"If you think the news about financial institutions will change the momentum globally then things might be different," said a trader for a U.S. investment bank.

"But you wouldn't normally think so. JGBs have been sold recently on factors such as worries about inflation, so it's hard to draw up a scenario of 10-year yields falling towards 1.5 percent," he said, adding that the tail at the auction could widen.

At the previous 10-year auction in May the tail on the auction reached 0.26, the widest since a 10-year auction held in September 2006, a sign of lacklustre demand. ($1=104.42 Yen) (Editing by Michael Watson)