UPDATE: Econ Concerns Drive Demand At 10-Year JGB Auction

TOKYO -- Demand was strong for 10-year Japanese government bonds at auction Tuesday, with investors believing that Japan's economy still has far to go before it pulls out of the doldrums.

Japan's Ministry of Finance sold Y1.918 trillion of the 1.5% bonds, a reopening of June's Issue No. 301, at a lowest price of 100.38 to yield 1.455%. The bonds yielded 1.452% at the average price of 100.41.

Several common indicators showed the healthy demand. The bid/cover ratio, which compares the number of bids received for each bond on sale, was higher at 2.91 than at all but one 10-year auction since March.

In addition, the gap between the average and lowest accepted prices, known as the tail, was tighter at 0.03 than the market's expectation of 0.04 or 0.05, Morgan Stanley strategist Noriyuki Fukuda said.

"Considering how much concern there has been about the longer bond auctions, and considering that we have a 30-year auction coming up on Thursday, I can say that the (10-year) auction went smoothly," Credit Suisse strategist Kenro Kawano said. "The 10-year offers the biggest carry and rolldown at the moment, and after the curve bear-steepened recently it looked very attractive, so a lot of buyers showed interest."

Mizuho Securities was the largest buyer Tuesday, taking Y179 billion of the bonds. Nomura Securities was next, with Y167.4 billion, followed by Nikko Citigroup with Y149.2 billion.

The real key will come after the auction, Morgan Stanley's Fukuda said.

"It could be just dealers who took all these bonds, so how the market closes is very important to the impression people get of the auction," he said. "We have to see whether the 10-year strengthens after this. If the market closes up after this, the auction will be considered a success."

As of 0445 GMT, an hour after the auction results came out, the market did indeed seem to be reviving as equities sold off. The 10-year yield had strengthened to 1.445% from 1.455%, still up 1 basis point on the day, while lead September JGB futures also were trimming losses, down 0.18 at 137.60 after getting as low as 137.45 in the morning.

Mitsubishi UFJ Securities strategist Naomi Hasegawa said the market was unlikely to move dramatically this afternoon.

"Investors are taking a wait-and-see stance to see whether yields will continue to rise and whether equity markets will continue to rally," she said.

In the medium-term, she predicted that bonds would continue to fare well.

"We expect that yields will come back down. The stock market rally may be extended but we're doubtful about its sustainability because the global economy still remains fragile - especially in Japan - and loan demand is quite sluggish, with money flowing into safe assets through bank deposits."