December 18, 2012 / 6:56 AM / 5 years ago

JGBs hit by worries over increase in stimulus-led debt issues

4 Min Read

* Possible increase in JGB issues early next year

* Abe's policy of "print and spend" raises worries

* Demand soft at 20-yr bond auction despite relative cheapness

* Short-dated paper seen supported by BOJ buying

* Headwind from hopes of US fiscal deal

By Hideyuki Sano

TOKYO, Dec 18 (Reuters) - Japanese government bond prices sagged on Tuesday with the benchmark 10-year yield hitting a one-month high on concerns of more debt issues following political pledges of large-scale stimulus to boost the economy.

In addition, expectations of aggressive monetary easing by the Bank of Japan, weak demand at a 20-year JGB auction and growing optimism on U.S. policymakers reaching a deal to avert a fiscal crunch all weighed on JGBs.

Shinzo Abe, Japan's incoming prime minister said he would compile a big supplementary budget to shore up the economy, fanning worries of more debt being issued to finance the stimulus.

"He's talking about a large-scale budget, so we have to think of a two-digit number," said Mari Iwashita, chief market economist at SMBC Nikko Securities, referring to the possibility the supplementary budget could top 10 trillion yen.

While part of such a budget can be funded by surplus in the current budget, analysts say the government will likely have to increase debt issues as soon as in February.

The increase would add to Japan's immense and snowballing public debt, which now amounts to about 200 percent of GDP.

The 10-year JGB yield rose 2.0 basis point to 0.755 percent , its highest level since Nov. 15.

The 10-year JGB futures fell 0.24 in price to 143.99 in heavy trade volume of 45,543 contracts, more than 60 percent above this year's average.

"The market is now worried about increase in debt issues. If investors start to see a recovery in the economy, then we will likely to see another round of selling. The 10-year yield could rise to around 0.9 percent," said a portfolio manager at a Japanese bank.

The auction of 1.2 trillion yen ($14.3 billion) 20-year government bonds on Tuesday drew weak demand, even though the spread between 10 and 20-year yield stood near 13-year highs.

The auction's tail - the gap between the lowest and average prices - was 0.19, widest in five months while bid-to-cover ratio was also the lowest in five months.

The new bonds were sold at high yield of 1.750 percent, highest level since March auction.

The current 30-year bond yield hit an eight-month high of 1.990 percent.

"Superlong" bonds such as 20- and 30-year bonds have been underperforming in the past month as the aggressive monetary easing Abe is calling for is thought to risk spurring uncontrollable inflation, perhaps not in the near future but some time during their 20-year or 30-year tenor.

Investors expect the Bank of Japan to heed Abe's call to adopt an inflation target of 2.0 percent, compared to the bank's current less explicit "goal" of one percent inflation.

Abe met BOJ Governor Masaaki Shirakawa on Tuesday for 15 minutes and asked him directly to consider just that, although Shirakawa stayed mum to reporters on the bank's stance.

The BOJ will also start two-day policy meeting from Wednesday. Some market players expect the bank to take fresh easing steps but other think the bank will wait until January, after Abe will formally take power and unveil the outline of his policies.

In any case, investors expect the BOJ to keep buying a large amount of short-term government debt to pump money into the market, limiting any losses in short-term bonds.

The five-year yield rose just 1.0 basis point to 0.185 percent, a one-month high.

The bonds were also hurt by rise in U.S. Treasuries yields on optimism that U.S. policymakers will avert a fiscal crunch.

President Barack Obama made an offer to Republicans that included a major change in position on tax hikes for the wealthy, significantly narrowing the differences between the two sides over how to resolve the fiscal cliff.

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