JGBs gain on Nikkei rout, 10-year yield hits 3-month low
* A break of key yield support surprises traders
* Hedge funds buy JGB futures while selling Nikkei futures
* Fall in repo rates also provides support
* Implied volatilities near 3-month lows
TOKYO, Aug 7 (Reuters) - Japanese government bond prices gained on Wednesday, with the benchmark 10-year yield slipping to a three-month low as a sharp fall in Japanese stock prices unpleasantly surprised traders who had bet a yield support would hold.
In addition, a fall in key short-term interest rates is supporting longer-dated bonds, though traders also say price actions may have been exaggerated by thin trading due to the summer lull.
The benchmark 10-year JGB yield dropped 3.0 basis points to 0.750 percent, its lowest level in three months and piercing a yield support of 0.770 percent, where it had rebounded twice in recent weeks.
"Most traders didn't want to carry long positions overnight at current levels. Many of them were also not expecting the BOJ to conduct bond buying operations this morning. So when it did, they were all forced to buy this morning," said a trader at a Japanese brokerage.
The BOJ offered to buy a total of 610 billion yen bonds on Wednesday as part of its plan to double its bond holdings by early 2015.
The BOJ conducts bond buying on about 10 days a month. With the BOJ being the single largest buyer of JGBs, whether or not it buys deeply affects positioning of traders.
Speculators such as commodity trading advisors were buying JGB futures on Wednesday while selling stock futures , as the Japanese yen also strengthened as a fall in world shares cut risk appetites, traders said.
The Nikkei share average fell 4.0 percent, its biggest fall in eight weeks.
On top of benefiting from the fall in stocks, the bond market was also supported by recent declines in repo rates, which market players say reflect the accumulated impact of the BOJ's massive asset purchases since April.
The overnight repo rate starting the next business day fell to a two-month low of 0.063 percent on Tuesday, moving away from its usual levels around 0.10 percent.
"Because the BOJ has been buying so many short-term bills, brokers have a limited inventory of bills. Their inventory is notably lower than before the BOJ's quantitative easing," said Akito Fukunaga, chief rates strategist at RBS.
"That is certainly making investors buy longer-dated bonds at lower yields," he added.
Despite a break of a key yield support, few market players expect the rally in JGB to gain momentum.
Some investors such as regional banks are looking to sell into the rally, anticipating a range-bound market as they expect a new trend only when investors get a clear picture on when the U.S. Fed will start trimming its stimulus.
Reflecting such expectations, implied volatilities on JGB futures options are under pressure, falling near their lowest levels in about three months.
Market players also said price actions in JGBs as well as in Japanese stocks are likely to be exaggerated by thin trading volume.
Wednesday's turnover of JGB futures was 19,797 lots, about 40 percent below the daily average this year.
The BOJ started a two-day policy meeting on Wednesday and is almost unanimously expected to keep its policy on hold.