JGB 10-yr yield hits 2-mth high on issuance worry

* Benchmark 10-year yield rises to 1.4 percent

* Lead 10-year JGB futures hit two-month low

* Cash bonds mixed, two-year JGBs and 30-year bonds firmer

* Ongoing worries about debt issuance weigh on market

TOKYO, Oct 27 - The benchmark 10-year Japanese government bond yield hit a two-month high on Tuesday, hurt by uncertainty over the size and details of upcoming debt issuance.

Investors are bracing for JGB issuance to the market to be increased this fiscal year to offset a tax revenue shortfall and to make up for weak demand for JGBs among retail investors.

They are also worried about how much debt may be issued in the 2010/11 fiscal year that starts next April.

This week's rise in 10-year U.S. Treasury yields on worries that the Federal Reserve may be mulling stepping away from a commitment to keeping interest rates near zero for an extended period, also weighed on JGBs.

"Although we are at the type of levels that attract sporadic buying, the risks are not going to go away immediately, so when there is a rebound the market tends to get hit by selling," said Jun Fukashiro, chief fund manager for Toyota Asset Management's investment management department.

"It is hard to get a sense of what a likely extra budget to deal with tax revenue shortfalls and additional economic steps might look like," Fukashiro said, adding that worries about extra debt issuance could push the 10-year yield to as high as 1.6 percent by the end of next March.

The benchmark 10-year JGB yield edged up 0.5 basis point to 1.400 percent, its highest level since mid-August.

Ten-year cash JGBs extended their losses in the wake of their sell-off on Monday, when the 10-year yield rose three basis points for its biggest one-day rise in three months.

Lead December 10-year JGB futures dipped 0.13 point to 137.86 in regular session trading.

The lead futures contract extended its losses in the evening session and fell to its lowest level in more than two months of 137.77.

Selling of JGB futures by hedge funds that trade based on their views of technical charts likely exacerbated falls in futures, said a trader for a European brokerage house, adding that volumes were relatively robust.

Thirty-year JGBs fared better, with their yield dipping 1 basis point to 2.285 percent.

The two-year yield eased 0.5 basis point to 0.275 percent and pulled away from Monday's high of 0.285 percent, which was the highest in nearly four months.

NEW BOND ISSUANCE

The market showed little reaction to finance minister Hirohisa Fujii, who reiterated on Tuesday that new bond issuance in fiscal 2010/2011 must be kept below 44 trillion yen.

Market players are sceptical that the government can keep new JGB issuance in the next fiscal year below 44 trillion yen, and investors think that even 44 trillion yen is a lot, said the trader for a European brokerage house.

Regarding debt issuance for the rest of the current fiscal year, the Ministry of Finance has held discussions with market participants about issuing to the market around 2.6 trillion yen ($28.1 billion) of debt that had previously been intended to be sold as retail JGBs, floating-rate and inflation-linked debt during the current fiscal year. The actual amount to be reallocated is undecided, MOF officials have said.

"The likely issuance increase as a result of the reallocation has already been factored in by the market. Market reaction has been relatively calm and this shows that it is prepared to absorb the increase without too much difficulty," said Koji Ochiai, a senior market economist at Mizuho Investors Securities.

The MOF held talks on Tuesday with institutional investors, who told the MOF that one-year to 10-year JGBs could best absorb a supply increase to the institutional market.

The views were similar to those expressed by primary dealers at a regular meeting with the MOF on Friday.

Past the reallocation, the market is bracing for an issuance increase that may be needed to cover an expected tax revenue shortfall.

Japan has already increased planned new JGB issuance to 44.1 trillion yen from 33.2 trillion yen but bond investors are eyeing that to rise to about 50 trillion yen as a result of the shortfall in tax revenue.

In addition to JGB issuance for new financing, the MOF also plans to issue 91 trillion yen in refunding bonds this fiscal year. According to plans announced in late April, the MOF plans to sell a total 130.2 trillion yen in JGBs to the market through regular auctions this fiscal year.