JGB 10-yr yield hits 9-mth high on auction worries

By Chikako Mogi

TOKYO, May 27 (Reuters) - The yield on benchmark 10-year Japanese government bonds rose to a fresh nine-month high on Tuesday on investor caution before a 20-year bond sale and as Tokyo shares rebounded from the previous day's declines.

But JGBs were able to trim losses, with futures moving into positive territory by midday in Tokyo, after an auction-related round of selling subsided on relief that the coupon for the new 20-year issue was the highest in more than three years.

Medium-term bonds underperformed the rest of the curve, pressured by selling from banks seeking to further reduce JGB holdings they had built up during the credit crisis. Their portfolios had been hit hard by sharp sell-offs over the past two months.

Life insurers and pension funds, looking to reshuffle their portfolios, were also behind the shedding of the five-year sector as they shifted funds to buy longer-dated bonds to match their liabilities, traders said.

"Cash bonds led the trade today, and futures were just dragged lower. When cash selling subsides, there is little reason for futures to face such heavy selling," said a dealer at a Japanese bank.

June 10-year futures 2JGBv1 inched up 0.04 point to end the morning session at 134.52, after falling as low as 134.02 -- just above a nine-month trough of 133.93 hit on Friday.

The benchmark 10-year yield JP10YTN=JBTC was up 0.5 basis point at 1.745 percent after rising as high as 1.785 percent, a fresh nine-month high.

The five-year yield JP5YTN=JBTC was up 1.5 basis points at 1.315 percent, after climbing as high as 1.355 percent, also a nine-month peak.

The two-year yield JP2YTN=JBTC hit a fresh seven-month high of 0.855 percent, before easing to 0.840 percent, up 1 basis point on the day. Some traders said caution before the two-year note auction on Thursday may have weighed on the bonds.

The 20-year JGBs outperformed, with the yield dipping 1.5 basis points to 2.345 percent.

The Ministry of Finance offered 800 billion yen ($7.74 billion) in 20-year JGBs with a 2.4 percent coupon, up from 2.2 percent in the April issue of the maturity and the highest since a July 2004 issue of 20-year JGBs.

Traders said the auction will likely draw fair demand, with the results due at 0345 GMT.

"If the auction result is fair, dip-buying could support the market, though insurers are unlikely to be aggressive buyers, limiting the market's upside," the dealer said.

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

"Market sentiment remains weak, with investors jittery about rising inflation," said Koji Ochiai, senior market analyst at Mizuho Securities.

"The range for yields is likely to be gradually revised upwards, with players increasingly seeing 1.7 percent as a floor for 10-year yields, and a 2.0 percent yield in sight."

The Nikkei stock average .N225 ended morning trade up 0.8 percent.

($1=103.42 yen)

(Editing by Brent Kininmont)