JGBs rise, futures hit 4-mth high as Nikkei slips

By Masayuki Kitano

TOKYO, Aug 7 (Reuters) - Japanese government bond futures climbed to a four-month high on Thursday as worries about the domestic economy's outlook and a fall in Tokyo share prices lured investors towards safe-haven debt.

Bond yields fell broadly, with the five-year yield hitting a four-month low and the two-year yield dipping to its lowest in three months, due to investor demand.

JGBs have rallied over the past couple of weeks as data pointed towards a downturn in Japan's economy, prompting investors to scale back expectations for a Bank of Japan rate rise in the financial year to next March.

"There are not many sellers and there's a lot of interest in buying bonds on dips, especially in the medium-term sector," said a dealer for a Japanese brokerage house.

JGBs also gained a lift because Tokyo share prices fell, with the Nikkei average .N225 down around 1 percent, despite a rise in U.S. share prices and the yen's fall to a seven-month low against the dollar on Wednesday, market players said.

September 10-year JGB futures rose 0.11 point to 137.30 2JGBv1, having pared some gains after climbing to a four-month high of 137.46 earlier. Trading volume was moderate, at around 16,000 contracts.

The 10-year JGB yield fell 0.5 basis point to 1.515 percent JP10YTN=JBTC, edging back towards a four-month low of 1.495 percent hit on Monday.

Yields on medium-term bonds fell the most, with the five-year yield hitting a four-month low of 1.020 percent JP5YTN=JBTC at one stage. It later pulled up from the low but was still down 2.5 basis points on the day at 1.030 percent.

Two-year yields, the sector of the JGB yield curve that is most sensitive to shifts in the monetary policy outlook, fell 1.5 basis point to a three-month low of 0.720 percent JP2YTN=JBTC.

The Finance Ministry offered 500 billion yen ($4.56 billion) in 10-year inflation-linked JGBs with a 1.4 percent coupon. The auction results are due later on Thursday.

CAUGHT OFF GUARD?

"The bond market's sentiment is strong," said Naomi Hasegawa, senior fixed-income strategist for Mitsubishi UFJ Securities.

Data showing that core private-sector machinery orders, a key gauge of corporate capital spending, fell by a smaller-than-expected 2.6 percent in June, did little to allay concerns about the economy's weakness.

This was especially the case because manufacturers forecast that core orders, regarded as a leading indicator of capital spending, would show a 3.0 percent fall in the July-September quarter from the previous quarter.

The fact that trading volumes have been low compared to when JGBs tumbled between early April and mid-June, may be a sign that some investors were caught off guard by the recent rally in JGBs, said Akito Fukunaga, fixed-income strategist for Credit Suisse.

"It suggests that JGB levels have rebounded before such players were able to rebuild positions that they had taken off earlier," Fukunaga said.

Daily trading volumes in JGB futures had languished below 40,000 contracts for about a month until Wednesday, when the rally in JGBs picked up steam and turnover rose to around 44,000 contracts.

JGBs rallied on Wednesday due to investor buying of cash bonds and some active receiving of interest rate swaps, especially in the eight-year to 10-year sector.

Further gains in JGBs are likely to be tempered by profit-taking, especially if the 10-year yield falls below 1.5 percent, analysts said.

"Players who bought 10-year JGBs at levels around 1.55 percent are already making a profit at current levels," said Atsushi Ito, fixed-income strategist for Morgan Stanley.

Until investors get a chance to see economic data for the July-September quarter, the 10-year JGB yield will likely trade between 1.6 percent and 1.45 percent, Ito said. (Editing by Chris Gallagher)