October 22, 2009 / 7:02 AM / 10 years ago

JGB 10-yr yield hits 2-mth high, supply woes linger

* JGB futures hit as speculators liquidate long positions

* Pull of riskier assets also seen hurting JGBs

* 20-yr swap spread turns positive for first time in a year

By Shinichi Saoshiro

TOKYO, Oct 22 (Reuters) - Japanese government bonds fell on Thursday, with the benchmark 10-year yield hitting a two-month high above 1.355 percent, as lingering concerns over a potential supply increase continued to hound the market.

The bond market was buffeted with futures hit by participants, including hedge funds and commodity trading advisors, liquidating long positions, market players said.

December 10-year JGB futures 2JGBv1 fell 0.31 point to 138.38 after brushing 138.25, their lowest since Aug. 17.

The Nikkei stock average .N225 dipped on Thursday but the pull of assets perceived to involve more risk was also seen hurting government debt.

“Stocks are steadily improving their footing, given the extra tailwind as the yen’s recent surge subsides. This is part of the reason behind the recent rise in long-term yields,” said Genji Tsukatani, head of fixed income investment management at asset manager Schroders.

The Nikkei shed 0.6 percent on Thursday, but the index has risen six percent from a 2-½ month low reached on Oct. 6.

The yield curve steepened a touch with yields of longer dated cash JGBs feeling the tug of continuing rises in yen interest swap rates — a result of paying in the swap market.

The five-year/20-year yield spread widened by half a basis point to 150.5 basis points, a fresh four-year high according to Reuters data.

The likelihood of added issuance for the current fiscal year through March 2010 — with the market bracing for planned new JGB issuance to be upped to around 50 trillion yen ($549 billion) from 44 trillion yen to plug an expected 6 trillion yen tax revenue shortfall — sent the benchmark 10-year yield sharply higher from an eight-month low of 1.240 percent hit earlier in the month.

Uncertainty over issuance plans for the next fiscal year starting in April 2010 have recently exerted additional steepening pressure on the yield curve.

The Bank of Japan’s easy monetary policy has helped underpin short to midterm JGB yields but the impact has not extended to longer dated maturities such as 20- and 30-year bonds.


Strong paying in yen swaps has been seen this week, particularly in longer dated maturities. Traders said this was caused by participants including hedge funds unwinding flattening positions as supply concerns dog the underlying JGB market.

Domestic banks’ selling of superlong JGBs after Tuesday’s poorly received 20-year sale also prompted paying in swaps, they said.

As a result of the strong paying the 20-year swap spread, the difference between the 20-year swap rate and cash JGB yield of the same maturity, rose back into positive territory for the first time in a year on Wednesday.

It was around 4 basis points on Thursday after falling to around minus 40 basis points a year ago in the wake of the financial market turmoil that followed the collapse of Lehman Brothers.

The 20-year swap spread may have returned to being positive due to special factors, such as the unwinding of flatteners, but the move still shows that conditions are steadily returning to normal in the swap market and the financial market as a whole, market players said.

Negative swap spreads are considered an anomaly. This is because swap contracts are backed by the creditworthiness of the institutions at the other end of the contract, and a negative swap spread implies that a risk of a government defaulting on its debt is greater than a private institution not meeting its obligations.

“The 20-year swap spread returning to positive territory is symbolic as it shows that swap market functions are returning to normal after collapsing in the wake of the Lehman shock,” said Katsutoshi Inadome, a fixed income strategist at Mitsubishi UFJ Securities.

The 20-year yield climbed 2 basis points to 2.145 percent JP20YTN=JBTC, after hitting 2.150 percent, its highest in two-months. The benchmark 10-year yield JP10YTN=JBTC rose 1.5 basis points to 1.360 percent, after brushing 1.365 percent, the highest since Aug. 17.

The five-year yield was up 2 basis points at 0.640 percent JP5YTN=JBTC. (Reporting by Shinichi Saoshiro; Editing by Joseph Radford)

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