Japanese government bond futures hit a four-month high for the second consecutive day on Tuesday as renewed worries about the health of the U.S. financial sector spooked investors and spurred selling of stocks.

The market extended gains as the Ministry of Finance’s 800 billion yen ($7.31 billion) sale of 20-year bonds attracted solid demand despite the lowest coupon in six months for that maturity, prompting primary dealers to cover short positions.

The stronger-than-expected auction results showed investor willingness to pick up government bonds, even after expectations that a global slowdown would hurt the Japanese economy have sent the benchmark 10-year yield to a four-month trough near 1.4 percent.

Still, analysts said the market seems to be settling into a lull around current yield levels, with benchmark yields holding around 1.4 to 1.5 percent as the economy has stalled and the Bank of Japan has made clear it has a neutral policy stance.

“There are not enough factors left to boost government bonds further,” said Atsushi Ito, a JGB strategist at Morgan Stanley.

Ito said investors would find it hard to push the 10-year yield below the key 1.4 percent level as the government is expected to outline an economic package soon, with any extra bond issuance to fund the spending seen as a potential negative for the market.

Economics Minister Kaoru Yosano said the cabinet wanted to compile the package by the end of the week, though the government had not yet decided its size or how it should be funded.

The ruling Liberal Democratic Party’s policy chief said on Monday the package could be worth 2-3 trillion yen ($18-27 billion), and the cabinet has agreed to start preparing for an extra budget to finance the spending.

September 10-year futures rose 0.39 point to 138.49, after striking a four-month peak of 138.53.

The benchmark 10-year yield dipped 1 basis point to 1.415 percent, staying near a four-month low of 1.405 percent touched on Monday.

The five-year yield dipped half a basis point to 0.990 percent.

Bucking the market, the two-year yield, the most sensitive to the monetary policy outlook, edged up 0.5 basis point to 0.690 percent.

BOJ Governor Masaaki Shirakawa said on Monday that central banks should be careful about the negative effects of keeping rates too low. He also downplayed the risk of a lengthy economic contraction.

The BOJ is expected to keep interest rates on hold at 0.5 percent for several months, but a cut is also seen as very unlikely because policy rates are already so low. Money market futures are showing little chance of either a rate hike or cut.

For that reason, JGB yields can only fall so far even if yields on U.S. Treasuries keep dropping, analysts said.

The yield on the No.103 20-year bond was unchanged on the day at 2.110 percent.

The auction of the new No.104 20-year note produced good results, with life insurers, pension funds and some overseas investors expected to buy the bond.

There were some concerns over investor demand prior to the auction as the coupon was set at 2.1 percent, down from 2.3 percent at last month’s issue and the lowest since February.

“Life insurers and pension funds realise the worsening condition of the economy, and that means they are not looking for any significant increase in yields,” said Kenro Kawano, a senior interest-rate strategist at Credit Suisse.

In the stock market, the Nikkei average fell 0.8 percent, with financial shares leading the way down after a drop on Wall Street sparked by the ninth U.S. bank failure this year.

In the U.S., worries about more asset write-downs sent shares of AIG to a 13-year low on Monday.

Source: http://www.afxnews.com

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