JGBs dip on paying in swaps, curve steepens

* Paying in swap helps steepen the yield curve

* Some see domestic banks buying bonds after new financial

* Curve may steepen further as fiscal worries undermine
long-dated bonds

By Hideyuki Sano and Takahiro Okamoto

TOKYO, March 28 (Reuters) – Japanese government bond prices
dipped on Monday, with paying in 10-year interest rate swaps
leading to a rise in yields as some market players bet on a
steepening in the yield curve down the road.

Most Japanese investors are expected to stay on the
sidelines at the end of the financial year on March 31 — as
they did on Monday — leaving the market to focus on what they
will do once the new financial year begins.

The spectre of a sharp economic downturn following the March
11 earthquake is likely to keep demand for fixed income solid,
while worries about growth in the government’s fiscal burden
could undermine longer maturities, market players said.

“Bond yields are unlikely to show a sustained rise but the
longer end of the market is likely to underperform given worries
about rises in debt sales in the future,” said Akito Fukunaga,
chief rates strategist at RBS Securities.

June 10-year JGB futures (2JGBv1: Quote, Profile, Research) dipped 0.16 point to
139.64. Trade volume was an extremely thin 9,601 contracts, the
lowest in more than three months and less than half of the
average so far this year.

As many Japanese players stayed away, a few foreign banks’
trading in the swap market set the overall tone.

Some banks were paying in 10-years while receiving 5-year
and 20-year rates and expectations of quarter-end paying by
Japanese banks also helped to lift swap rates.

The 10-year swap rate rose 2.2 basis
points to 1.229/329 percent from levels late last week. The
spread between swap rates and JGB yields has almost returned to
pre-earthquake levels, reversing sharp tightening following the
quake, tsunami and subsequent nuclear troubles.

That led to the 10-year zone underperforming in the cash
bond market as well.

The current 10-year JGB yield rose 2.5 basis points
to 1.240 percent, while the 5-year yield rose 1.0
basis point to 0.475 percent. The 20-year yield
gained 3.0 basis points to 2.030 percent. .

The yield curve steepened with the yield spread between 5
and 10-year yields rising to 76.5 basis points, the highest
since early December.

“I think the 5-10 year spread could rise to increase to
around 90 basis points over the next three months,” said
Fukunaga at RBS.

Many market players think long-dated bonds could bear the
brunt of worries that reconstruction needs will strain Japan’s
already tattered finances.

On the other hand, the short end of the market will be
supported by expectations that the Bank of Japan will need to
keep pumping funds as Japan has to foot the huge bill for

“It’s hard to tell at this point what investors will do at
this point but I do think that short-term bond yields have more
room to fall, given that the Bank of Japan is expected to keep
its loose policy for longer than previously thought after the
earthquake,” said Keiko Onogi, a senior JGB strategist at Daiwa
Securities Capital Markets.

Japanese banks also have abundant cash, part of which is
likely to find its way to bonds, said Jun Ishii, chief
strategist at Mitsubishi UFJ Morgan Stanley Securities.

“Japanese companies’ fund surplus has now reached about 6.8
percent of GDP if you look at the moving average for four
quarters. This is likely to help further widen the 150 trillion
yen gap between banks’ lending and deposits. So the capacity for
banks to buy bonds is still there,” Ishii said.

Traders also said the market is likely to be supported in
the near future as it will take at least a few months before
the government can compile supplementary budgets for its
quake-relief efforts and for actual increases in bond issues to
take place.

“For the moment, I think the market will be looking at how
the quake has hurt corporate earnings. I’m pretty sure we’ll see
ugly numbers. The money for reconstruction will start moving
only in the second half (from October) of the financial year,”
said a trader at a Japanese bank.

(Takahiro Okamoto is a senior rates analyst at IFR Markets;
Editing by Edwina Gibbs)

JGBs dip on paying in swaps, curve steepens