JGB futures up on short-covering after tumble

By Satomi Noguchi

TOKYO, May 19 (Reuters) - Japanese government bond futures climbed on Monday, pulling away from a seven-month low in thin trade as dealers covered short positions after a tumble late last week.

Analysts said a sharp slide late on Friday looked overdone, prompting some investors to pick up the debt, though cautiously.

"The market gained a sense that the fall on Friday was too much," said Maki Shimizu, a JGB strategist at UBS Securities Japan.

The market remained unstable however after volatile sessions last week. JGB futures had plunged nearly two full points on Wednesday, reminding investors of a sell-off in late April that had led the lead contract to post its biggest one-day loss in five years.

JGBs have moved sharply as the volatility of the past two months has prompted hedge funds and other players to pull back from the market, hurting liquidity and exacerbating price swings, analysts said.

June 10-year futures jumped 0.57 point to 135.28 2JGBv1, rebounding from a seven-month low of 134.28 hit last week. It rose as much as 0.59 point at one stage to 135.30 as buying from foreign players emerged, traders said.

The benchmark 10-year yield fell 3 basis points to 1.665 percent JP10YTN=JBTC.

On Friday, the 10-year yield climbed to a seven-month high of 1.710 percent as investors dumped government bonds after a disappointing Bank of Japan buying operation, which highlighted how much traders wanted to get rid of their bond holdings.

JGBs drew some support on Monday from data that showed Japanese manufacturers turned pessimistic about business conditions for the first time in five years in May as high raw material prices and a U.S. slowdown eroded sentiment.

The Reuters tankan, a monthly survey of leading Japanese firms that tracks the BOJ's influential corporate survey, produced an index of minus 2 for manufacturers, down from plus 1 in April. [ID:nTKG003086]

BOJ MEETING IN FOCUS

The BOJ holds a policy-setting meeting on Monday and Tuesday, at which it is widely seen leaving interest rates unchanged.

The market is eager to hear what BOJ Governor Masaaki Shirakawa has to say at the post-meeting news conference about rising prices in food and commodities and their impact on the economy.

The interest rate derivative market shows more investors believe the BOJ will eventually boost rates from the current 0.5 percent given a market perception that the worst of the credit market turmoil is over and that the Federal Reserve could raise U.S. rates later this year.

Akihiko Yokoyama, chief JGB strategist at JPMorgan Securities, however said that Shirakawa had suggested the central bank would likely keep rates on hold for a while, and that comment should push yields of short- and medium-term notes down further.

Last week, Shirakawa suggested that economic weakness from high oil prices could hold back rates or even lead to cuts, even if higher prices pushed up inflation.

But Yokoyama added: "A market plunge last week also suggested investors were demanding extra premium on JGB yields amid high volatility, and it may take some time for the market to return to normal trade."

The central bank shifted to a neutral stance on rates at the end of April, dropping its previous bias towards raising rates, and saying downside risks to the economy would likely dominate in the near term.

The five-year yield dropped 4.5 basis points to 1.235 percent JP5YTN=JBTC, off a nine-month high of 1.320 percent struck last week.

The 20-year yield was down 2 basis points at 2.245 percent JP20YTN=JBTC.