JGBs inch up

Japanese government bonds edged up on Tuesday, taking their cue from a rise in US Treasuries the previous day, but prices remained capped ahead of Japanese data due later in the week. The market showed a limited reaction to an auction of two-year notes, which drew decent demand in line with expectations.
Dealers picked up the new issue to cover short positions created in a sharp sell-off over the last month or so. "Selling pressure has weakened a lot, while short covering is continuing, so yields have slipped a bit," said an analyst at a US securities firm.
But she added that yields were unlikely to head further south, particularly if this week's data indicates that the economy remains on a solid footing, clearing the way for the Bank of Japan to raise rates in the coming months.
Japanese industrial output, consumer prices, household spending and employment figures are due later in the week, followed by the BoJ's quarterly tankan survey of business sentiment early next week. Dealers said that overall, demand would be limited as long as market views stayed intact for a Bank of Japan rate increase as early as August.
September futures were up 0.05 point at 131.75, staying away from 130.76 - the lowest since 2000 - hit earlier this month when investors dumped bonds on concerns of rising global yields and growing expectations for an August rate rise.
The benchmark 10-year yield fell 1.5 basis points to 1.875 percent, well below an 11-month high of 1.985 percent hit earlier in the month. The two-year yield eased 1 basis point to 0.995 percent, while the five-year yield slipped by the same amount to 1.485 percent.
But even though two- and five- year yields slid below key levels of 1 percent and 1.5 percent, respectively, market participants said such levels were not sustainable.
"There is little incentive for players to push yields lower, and investors are turning very cautious as the five-year yields dipped below 1.5 percent," said a senior dealer at a Japanese bank. "Investors just don't want the medium maturity with yields of less than 1.5 percent."
JGBs were supported by Treasuries, which rose on Monday on a slide in existing home sales, as well as safe-haven buying on falling stocks and concerns that problems in hedge funds with large subprime mortgage holdings could spill into wider financial markets.
SMOOTH AUCTION The Ministry of Finance's 1.7 trillion yen offer of two-year notes produced a lowest price of 99.950, in line with market expectations.
The 1.0 percent coupon was unchanged from that of last month's auction, which was the highest in a decade. Analysts said that demand was lower than the previous offer, but that dealers considered the issue a good chance to cover short positions.