TREASURIES-Futures slip in Asia with JGBs, LIBOR mulled

By Eric Burroughs

TOKYO, June 2 (Reuters) - U.S. Treasuries slipped in Asia on Monday, with some investors selling futures on a tumble in Japanese government bonds as dealers fretted about demand at an auction the next day.

Selling in Treasury futures was also spurred as Japan's Nikkei share average .N225 climbed 0.5 percent, rebounding from an initial dip. But activity was very light, and flows were few and far between, traders said.

Market players are gearing up for the Institute for Supply Management's factory report for May later in the day, which is expected to show a mild contraction in activity for a fourth straight month. In a Reuters poll, the ISM index is forecast to be virtually unchanged at 48.5. ECONUS

The sell-off in Treasuries that has driven the benchmark 10-year yield to a five-month peak above 4.0 percent has added fuel to the slide in other major bond markets as investors believe central banks will tighten policy to keep inflation contained.

This week's data, including the monthly payrolls report, will test market expectations that the Federal Reserve could start raising rates by the end of the year after having signalled that it is less likely to cut them further from 2 percent. FEDWATCH

June T-note futures TYv1 dipped 3.5/32 to 113-27/32 on light volume of a little more than 3,000 lots.

The benchmark 10-year note US10YT=RR was unchanged in price to yield 4.067 percent, off a five-month peak of 4.14 percent hit on Thursday. Two-year notes US2YT=RR were also flat to yield 2.650 percent.

The curve spread between two- and 10-year yields was mostly steady at 142 basis points, holding off a low of 137 basis points hit last month, the flattest level since mid-January.

Investors also shrugged off the British Bankers' Association saying on Friday that it will beef up supervision of how LIBOR rates are set following criticism that some contributing banks were providing rates that did not reflect market conditions. [ID:nN30466480]

"The BBA shows no inclination to tinker with the rate-fixing process," said analysts at money market research firm Wrightson ICAP in a note to clients.

Wrightson said that a revival in medium-term debt issuance by financial institutions may eventually take some of the pressure off interbank funding needs and narrow the spreads of LIBOR compared with expected policy rates.

But the fact that LIBOR has not responded much to the recent revival of bond issuance suggests that the implied 50 basis point premium above the expected overnight rate is becoming the new market standard, Wrightson said.

"In the absence of some positive shock, it could remain entrenched for some time to come," Wrightson said.

The three-month dollar LIBOR rate LIBOR has shrunk to 68 basis points above three-month OIS USDOIS, but that remains well above the levels near 10 basis points that prevailed before the money market crunch erupted last August.