* Longest maturities outperform, auguring well for 40-yr auction
* Sharp gains in Japanese shares prompts portfolio rebalancing
* Market also supported by expectations of aggressive BOJ easing
* JGB futures rise above Ichimoku cloud top
By Hideyuki Sano
TOKYO, Feb 12 Long-dated Japanese government bonds firmed on Tuesday as investors snatched up the longest maturities even ahead of an auction of 40-year JGBs the following day, as they rebalance their portfolio after sharp gains in Japanese equities.
Also supporting the market, short-term notes yields were stuck near historic lows, helped by expectations that the Bank of Japan will step up its stimulus to lift inflation to 2 percent.
The 30-year bond yield fell 2.5 basis point to three-week low of 1.965 percent, outperforming shorter maturities while the 20-year bond yield also fell 1.5 basis point to 1.760 percent, its lowest in nearly three weeks.
Some passive fund mangers appeared to be buying bonds as recent gains in Japanese share prices made their portfolio too overweight on stocks, market players said.
Japan's Nikkei share average has risen almost a third since mid-November. On Tuesday it climbed 1.9 percent to edge near a 33-month high as the yen weakened after a U.S. Treasury official voiced support for Japan's aggressive policies to combat deflation and boot growth.
The strength of "superlong" bonds also pointed to the market's optimism on an auction of 400 billion yen ($4.25 billion) 40-year JGBs on Wednesday.
"It seems like the market is trying to buy (super-long bonds) in advance ahead of the auction," said Yuya Yamashita, strategist at JPMorgan Securities.
Investors are heading for the long end of the yield curve, as short-term bond yields have fallen to painfully low levels since last week.
The five-year yield hit a record low of 0.135 percent while the two-year yield to a 10-year low of 0.025 percent.
The catalyst for the sharp fall in short-term bond yields was the announcement from BOJ Governor Masaaki Shirakawa that he will step down in March, three weeks before his term expires.
He has long resisted cutting interest rates to zero but Prime Minister Shinzo Abe is expected to name a sympathiser of his reflationary policy agenda to succeed Shirakawa later this month.
Market players expect a new governor, whoever that will be, to scrap interest payments on banks' excess reserves, a step that is likely to let all money market rates fall to zero.
The five-year bond yield stood flat at 0.135 percent on Tuesday while the two-year notes were untraded.
Unlike the cash bond market, however, many short-term rates in the derivative markets have not fallen below their December lows, suggesting the strength in short-term bonds also reflected tight demand in the cash bond market as the Bank of Japan soaks up a large amount of bonds from markets in its asset purchase scheme.
The 10-year bond yield fell 0.5 basis point to 0.750 percent while the 10-year JGB futures price rose 0.08 point to 144.30, rising above the top of cloud on the daily Ichimoku chart, a bullish technical sign.
Like most other financial markets, JGBs showed no reaction to news that North Korea had conducted a nuclear test.