November 9, 2012 / 6:45 AM / in 5 years

JGBs rise as US fiscal fears fuel demand for bonds

* 10-yr futures end at highest level since July

* 10-, 2--yr yield spread could further narrow- strategist

By Lisa Twaronite

TOKYO, Nov 9 (Reuters) - Japanese government bonds rose on Friday, pushing down benchmark yields to one basis point shy o f a 9-year low, as fears about a looming U.S. fiscal deadlock underpinned fixed-income assets.

The U.S. economy faces a so-called “fiscal cliff” of about $600 billion in expiring tax cuts and spending reductions due to take effect in January, unless newly re-elected President Obama can reach a deal with Congress to curb the deficit.

“Japanese investors are certainly interested in how the U.S. comes to terms with this and are following it,” said Tomohiro Miyasaka, an analyst at Credit Suisse in Tokyo.

The U.S. government must also reach an agreement to raise its debt ceiling to avoid a government shutdown. The outcome of these issues could have implications for the Treasuries market, and by extension on JGBs.

Concerns about the euro zone also bolstered demand for bonds, after European Central Bank president Mario Draghi sounded downbeat on the euro zone economy on Thursday. The ECB held rates steady as expected.

The 10-year yield slipped 1 basis point to 0.730 percent, its lowest level since Aug. 3 and not far above its nine-year low of 0.720 percent touched several times in July. That level has been its lowest since June 2003.

Some strategists and market participants believe the July low is the market’s next target on the way to further declines, while others think rates might be close to a bottom at their present levels.

“There’s only a small chance that benchmark JGB rates will move as low as 0.70 percent, but whether they can rise from here depends to a large extent on the direction of U.S. Treasuries,” said Ayako Sera, a market economist at Sumitomo Trust and Banking.

Ten-year JGB futures ended up 0.06 point at 144.56 after rising as high as 144.61, their highest level since July 25.

The superlong sector continued to rise in the wake of solid demand at Thursday’s 40-year auction, with yields on 30-year bonds losing 1.5 basis points to 1.900 percent, their lowest since Oct. 3.

Yields on 20-year debt fell 1 basis point to 1.650 percent after earlier touching 1.640 percent, their lowest since Sept. 27.

The spread between 10-year and 20-year yields shrank to 0.92 percentage point from 0.93 point on Oct. 30 on a last-traded basis, and some strategists say it could contract further as the yield curve flattens.

The 10/20 spread can return to 0.85 point, so the current level is attractive for establishing a flattener position, strategists at Barclays advised clients in a research note on Friday.

The yield curve steepened at the end of last month as longer maturities underperformed due to concerns about possible issuance disruption if a deficit-financing bill needed to fund this fiscal year’s budget failed to pass this month. But those concerns dissipated as the government and opposition parties appeared closer to an agreement on its passage.

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