* Futures post biggest two-day loss in 2 1/2 years
* Soaring stocks undermine investors' confidence in JGBs
* Fed's exit talk and drop in U.S. Treasuries also negative
* Investors on sidelines ahead of Tuesday's 30-year JGB auction
* Rise in market volatility could spur more selling
By Hideyuki Sano
TOKYO, May 13 Japanese government bond prices dived for two straight sessions on Monday as soaring Japanese share prices prompted investors to question their long-standing confidence in low-risk but low-yielding Japanese government bonds.
The benchmark futures price posted its biggest two-day decline in almost two and a half years to hit a one-year low, with the Tokyo Stock Exchange briefly suspending trading as a circuit breaker was triggered.
"I just don't feel like buying. It's too scary now. You shouldn't try to catch a falling knife. It's not a good time to try to be a hero," said Tadashi Matsukawa, head of fixed-income at Pinebridge Investments in Tokyo.
The benchmark 10-year bond futures fell 0.75 point in price to 142.95 after a 0.98 point fall on Friday. At one stage, they fell as low as 142.65, the lowest level for the benchmark contract in a year.
The 10-year cash bond yield rose to as high as 0.800 percent
, its highest level since early February. It last stood at 0.790 percent, up 9.5 basis points from Friday, after having posted its biggest rise in five years.
"It seems big players are offloading their bond holdings. It's as if 'portfolio rebalancing' is about to start," said Hidenori Suezawa, chief strategist at SMBC Nikko Securities.
Suezawa was referring to a theory, espoused by proponents of central banks' quantitative easing, that a central bank's bond purchase should force investors to buy other assets and boost their prices.
Japanese share prices surged to a fresh 5-1/2-year high as the yen plunged to a 4-1/2-year low against the dollar on the back of Japan's aggressive policy to bolster the economy by monetary easing.
JGBs initially reacted positively to the BOJ's massive easing, as market players thought the BOJ's monthly purchase of 7.5 trillion yen of JGBs could lead to a scarcity of bonds, but it did not take a single day for the market to reverse course.
The 10-year yield is now more than 2.5 times as high as its record low of 0.315 percent hit the day following the BOJ's easing on April 4.
As a part of the two-year stimulus plan, the BOJ bought 1.2 trillion yen of bonds on Monday, but that failed to stop the market's rout.
"It appears the BOJ wants to stop bond yields rising further from current levels around 0.75 percent," said Katsutoshi Inadome, strategist at Mitsubishi UFJ Morgan Stanley Securities.
"Nonetheless, JGBs could fall further if U.S. Treasuries decline. Investors are starting to question the idea that JGB yields should fall because the BOJ is buying bonds," he added.
Adding fuel to the sell-off, 10-year U.S. bond yields also rose to a seven-week high as recent strength in U.S. jobs data fanned speculation the Fed could pare its bond buying later this year.
The five-year yield rose to a 13-month high of 0.340 percent and last stood at 0.335 percent, 5.5 basis points above Friday's settlement.
As five-year paper is among favourite maturities for banks, market players suspected there was big selling by a Japanese bank.
Part of the market's weakness also stemmed from caution ahead of Tuesday's 500 billion yen ($4.91 billion) 30-year bond auction.
The 30-year bond yield rose to a high of 1.785 percent , its highest in two months, at one point. It last stood at 1.760 percent, up 5.0 basis points on the day.
For now, a possible support for price, and resistance for yield, is seen at 0.840 percent in the 10-year yield, a yield high marked in January.
"Banks' funding costs are around 0.8-0.9 percent so there will be some buying above that level," said SMBC Nikko's Suezawa.
But Suezawa also added that a rise in market volatility, if it continues, could force more selling by banks and other investors, who have to limit their exposure to market volatility at a certain level.