Japanese government bond futures fell sharply on Wednesday as Tokyo stocks rose more than 2 percent on news that the U.S. Federal Reserve would rescue insurer American International Group.

U.S. Treasury yields also rose in Asian trade, with the two-year note’s yield jumping to 2 percent from 1.79 percent late in New York on Tuesday.

The Fed said it would provide an $85 billion bridge loan to AIG and take nearly 80 percent in the company in a dramatic about-face as victims of the financial crisis kept piling up. [ID:nWEQ000175]

The news eased investor appetite for safe-haven government debt securities.

While futures’ slide was due given their recent sharp gains that have made them expensive compared with cash bonds, selling of cash JGBs was limited due to the lingering jitters and uncertainty over the U.S. financial system, traders said.

“Selling is limited, reflecting how JGB market players are not fully convinced of the rescue plan and thus are unwilling to make a one-way bet,” said Tatsuo Ichikawa, bond strategist at RBS Securities in Tokyo.

The lead 10-year JGB futures contract fell as much as 1.39 point to 138.06, before trimming some losses to 138.39, down 1.06 point. Futures soared by the daily limit of 3 full points on Tuesday on safe-haven buying in the wake of the collapse of Lehman Brothers.

The benchmark 10-year JGB yield rose 3 basis points to 1.495 percent, moving away from a five-month low of 1.375 percent hit on Tuesday.

“Selling of futures is a natural course as AIG’s rescue is good news for stocks, and pushed Treasuries lower,” said a trader at a Japanese insurance firm.

“Selling is led by futures, which have been extremely pricy, but cash bonds are supported by simmering concerns about the global credit market and deteriorating economies,” he said.

The Nikkei ended the morning up 2.1 percent.

Reduced incentives for flight-to-quality hit shorter maturities, with two-year yields rising 3 basis points to 0.730 percent and five-year yields rising 4 basis points to 1.080 percent. Both yields fell to five-month lows on Tuesday.

AIG is the latest company to be slammed by the mortgage and credit crisis. Lehman filed for bankruptcy protection and Merrill Lynch & Co agreed to sell itself to Bank of America Corp this week.

AUCTION EYED

The collapse of Lehman has raised concerns about the outcome of the 20-year JGB auction due on Thursday, as Lehman was among the top bidders at JGB auctions, particularly in the super-long maturities, traders said.

Traders were worried that the absence of a key primary dealer could make securities firms even more cautious about bidding at the auction, leading to a weak result and pushing yields on longer-dated bonds higher.

Securities firms, hit by the financial market turbulence, have become extremely cautious about actively bidding at auctions for fear of being left with bonds they can’t sell to investors.

The Ministry of Finance will sell 800 billion yen ($7.60 billion) in 20-year JGBs on Thursday, with traders looking for a 2.1 or 2.2 percent coupon, compared with a 2.1 percent coupon at the maturity’s auction last month.

The Bank of Japan ends its two-day policy meeting on Wednesday, with traders and analysts expecting the central bank to hold interest rates steady at 0.5 percent.

“The focus is whether there is a change in the BOJ’s risk balance,” said Koji Ochiai, a senior market economist at Mizuho Investors Securities. The BOJ has said it is watching both the risks of slowing growth and accelerating inflation.

The BOJ injected 2 trillion yen of funds into the money market via a same-day operation earlier than its usual operation time, as the overnight call rate rose as high as 0.72 percent, sharply above the BOJ’s 0.5 percent policy target. Foreign players were seen scrambling to raise funds, traders said.

The Fed kept interest rates unchanged on Tuesday.

($1=105.32 Yen)

Source: http://www.afxnews.com

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