May 3 (Bloomberg) -- Japanese bonds fell, paring this week's gains as traders increased bets the Federal Reserve is done with reducing interest rates and stocks rose on signs credit-market turmoil is easing.
The difference between 10-year Japanese and U.S. yields has widened from the narrowest in at least a decade in the past seven weeks, reducing the appeal of the Asian nation's debt. The Nikkei 225 Stock Average, which is inversely correlated with bonds, completed its seventh-weekly gain.
``Speculation the Fed is done with rate reductions boosts the U.S. and Japanese bond yields,'' said Takeo Okuhara, a bond strategist in Tokyo at Daiwa Institute of Research Ltd., a unit of Japan's second-largest broker. ``The pace of increase in yields may be faster in the U.S. but Japanese yields will follow their move. Rising stock prices will'' hurt bonds.
The yield on the 1.3 percent bond due March 2018 rose 6 basis points yesterday to 1.635 percent at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price fell 0.497 yen to 97.154 yen. Five-year yields climbed 4.5 basis points to 1.16 percent.
Ten-year yields may rise to 1.65 percent and five-year to 1.28 percent in the next 10 days or so, Okuhara said.
Bond futures for June delivery fell 0.65 to 135.75 at the Tokyo Stock Exchange and the Nikkei 225 added 2.1 percent yesterday and increased 1.3 percent this week.
Losses in bonds accelerated on speculation some traders wanted to sell before a four-day weekend in Japan amid expectations U.S. bonds will keep falling, said Koji Ochiai, a senior market analyst in Tokyo at Mizuho Securities Co. Japan's markets will be closed May 5 and 6 for public holidays.
``People who managed to buy debt on dips after a sharp drop last week may want to sell before the long weekend,'' he said.
Stock Advances
The gap in yields between U.S. and Japanese 10-year bonds was about 2.2 percentage points yesterday, compared with 2.01 percentage points on March 17, the lowest in at least a decade, according to data compiled by Bloomberg Data.
The odds of the Fed keeping rates at 2 percent at the next meeting in June increased to 80 percent from 78 percent on May 1, futures on the Chicago Board of Trade show. The BOJ left interest rates unchanged at 0.5 percent on April 30.
Japan's government bonds have handed investors a loss of about 1.2 percent in the past month, according to indexes compiled by Merrill Lynch & Co. The Nikkei 225, which had a correlation of 0.64 with benchmark yields so far this year, has increased about 8.8 percent in the same period. A correlation of 1 means the two moved in lockstep.
Even so, five-year benchmark notes completed the first weekly gain in five on speculation the Bank of Japan will refrain from raising interest rates this year. Yields on the notes have declined about 8 basis points this week. A basis point is 0.01 percentage point.
`Neutralized Themselves'
``They had a bias towards a rate hike, but going forward they have neutralized themselves and they emphasized the downside risks of the economy,'' said Hitomi Kimura, a bond strategist in Tokyo at JPMorgan Securities Japan Co., one of 26 primary dealers obliged to bid at debt sales.
The chance that the Bank of Japan will raise interest rates by a quarter-percentage point to 0.75 percent by the end of the year was 51 percent yesterday, compared with 80 percent at the beginning of the week, calculations by JPMorgan Chase & Co. using overnight interest-rate swaps show.
The world's second-largest economy will grow 1.5 percent in the year ending March 31, less than an October estimate of 2.1 percent, the central bank said in its semi-annual outlook report released on April 30. Core consumer prices, which exclude fresh food, will rise 1.1 percent, compared with an earlier estimate of 0.4 percent, the bank said.
BOJ Governor Masaaki Shirakawa told reporters the risk of an economic slowdown outweighs the possibility that conditions will improve.
Debt Auction
Government bonds also fell on speculation some investors sold before a 10-year auction next week, according to Mitsubishi UFJ Securities Co. in Tokyo.
Brokerages bidding at the 1.9 trillion yen ($18.2 billion) sale of 10-year bonds on May 8 may reduce debt holdings in case prices decline before they can pass on the new debt to investors.
``The 10-year auction next week is another reason why investors can't buy JGBs aggressively, especially with the uncertainty of holidays,'' said Takashi Nishimura, an analyst at Mitsubishi UFJ Securities Co. in Tokyo. ``They may want to hedge and they don't want to lower yields'' before the auction.
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