JGBs at new highs as Fed liquidity steps doubted

By Chikako Mogi

TOKYO, March 13 (Reuters) - Japanese 10-year government bond futures hit a 2-½ year high on Thursday, as doubts grew about the impact of the Federal Reserve's latest liquidity measures in easing the credit crisis.

The benchmark 10-year yield also fell to its lowest level in nearly three years as the JGB market drew support from a rise in U.S. Treasuries on Wednesday and a 2 percent drop in Tokyo shares.

Scepticism over the Fed's plan to inject billions of dollars of liquidity in the market kept alive market expectations the Fed would make bold interest rate cuts to try to shore up the U.S. economy.

While market players are watching Japan's political tussle over who will succeed Toshihiko Fukui as governor of the Bank of Japan, their main focus was on the credit crisis.

"The Fed's latest measure was seen as ineffective in resolving the credit market strains, keeping intact investors' flight-to-quality preference," said Akihiko Yokoyama, chief JGB strategist at JPMorgan Securities.

June 10-year futures 2JGBv1 hit a 2-½ year peak of 139.83, up 0.39 point on the day and the highest level since September 2005. The lead contract ended the morning session up 0.29 point at 139.73.

The benchmark 10-year yield JP10YTN=JBTC fell 2 basis points to 1.310 percent, after hitting 1.305 percent, its lowest since July 2005. The 20-year yield JP20YTN=JBTC held steady at 2.045 percent.

The two-year yield JP2YTN=JBTC dropped 1.5 basis points to 0.560 percent, while the five-year yield JP5YTN=JBTC fell 3.5 basis points to 0.745 percent.

Yokoyama said a renewed bid for safety by investors would flatten the curve out to 10 years as investors focused on liquid maturities of seven to 10 years. So the curve beyond 10 years would steepen, he said.

Traders said two- to five-year yields had relatively little room to decline further unless expectations for a BOJ rate cut grow.

The five-year yen swap spread JPYSB6L5Y= was quoted near 34 basis points, up from around 30 on Wednesday, but still below 41 basis points seen earlier in the week.

With hopes fading for the Fed measures to have significant impact on easing the credit strains, moves by hedge funds and other players, mostly foreign, to unwind their bad bets in the yen interest rate swap market and also in other securities such as inflation-linked bonds were likely to continue, traders said.

"Products preferred by foreign investors, such as 30-year, inflation-linked or floating-rate JGBs, could become relatively cheap as they unwind their holdings and could offer bargain opportunities for Japanese investors," said Atsushi Ito, a JGB strategist at Morgan Stanley.

Japanese money markets remained stable despite the troubles elsewhere that prompted the new liquidity measures.

The overnight call rate JPONMU=RR traded a tad above the BOJ's 0.5 percent target, spurring the central bank to inject cash through a same-day funding operation.

Overnight call rates inched up ahead of Friday's end of the BOJ's monthly reserve maintenance period.