July 2 (Bloomberg) -- Japanese government bonds advanced, pushing 10-year yields toward the lowest since May 13, on concern the world's second-largest economy is slowing.

Benchmark debt advanced after the Nikkei newspaper said the Bank of Japan at the July 14-15 board meeting may downgrade its economic outlook and revise the assessment for this fiscal year to mention ``downside'' risks. A U.S. report tomorrow is forecast by economists to show that Japan's largest export market cut jobs for a sixth consecutive month in June.

``The real global economy may continue to decelerate or fall into a recession,'' said Susumu Kato, chief economist in Tokyo at Calyon Securities, one of the 26 primary dealers required to bid at government debt sales. ``Investors have been waiting for opportunities to come back to the JGB market.''

The yield on the 1.8 percent bond due June 2018 fell 2 basis points to 1.655 percent as of 4:25 p.m. in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price rose 0.172 yen to 101.239 yen.

Five-year yields lost half a basis point to 1.25 percent. A basis point is 0.01 percentage point.

Ten-year bond futures for September delivery were little changed at 134.68 as of the afternoon close on the Tokyo Stock Exchange and the Nikkei 225 Stock Average lost 1.3 percent.

The Bank of Japan's Tankan index of business sentiment slid for a third straight quarter to 5 points in June from 11 in March, a report yesterday showed. A positive number means optimists outnumber pessimists.

All About Stocks

Japan's benchmark bonds have handed investors a loss of 0.4 percent so far this year, compared to a 2.5 percent return for holders of U.S. Treasuries, according to indexes compiled by Merrill Lynch & Co. The Nikkei has lost 13 percent in the same period, including reinvested dividends.

``Bonds are being bought because the equity market is declining,'' said Keiko Onogi, a debt strategist at Daiwa Securities SMBC Co., a primary dealer in Tokyo. ``It's all about the equity market.''

Japan's bonds often move in the opposite direction to stocks. Benchmark 10-year yields had a correlation of 0.89 with the Nikkei 225 since June 27, according to Bloomberg data. A value of 1 means the two moved in lockstep.

Bonds `Overbought'

Benchmark bonds will fall should the U.S. Labor Department report tomorrow show job cuts in Japan's largest export market were smaller than economists expected, said Alessio Caldarera, a fixed-income strategist at BNP Paribas Securities in Tokyo.

``The bond market is overbought so it cannot rally a lot more from here, even if we have weak jobs data,'' he said.

U.S. payrolls shrank by 60,000 workers, according to the median estimate of economists surveyed by Bloomberg News.

The 10-day relative strength index, a technical chart used to measure potential turning points in bond movements, reached 30.9 for 10-year yields on June 27. A level below 30 suggests buying of the bond may have peaked. Ten-year yields declined 15 basis points last week.

Demand for bonds may also be limited before a Ministry of Finance sale of 1.9 trillion yen ($17.9 billion) in 10-year securities tomorrow. Primary dealers, which are obliged to bid at auctions, typically reduce holdings of bonds before government debt sales in case prices decline before they can pass on the new securities to investors.

``We know that there is a risk of inflation and the yield may go up, so there isn't much appetite for bonds,'' said Yuuki Sakurai, general manager of financial and investment planning in Tokyo at Fukoku Mutual Life Insurance Co., which manages the equivalent of $54 billion in assets.

Auction Coupon

Current yields suggest the Ministry of Finance will set a 1.7 percent coupon on the new 10-year securities, 0.1 percentage point lower than at the last auction on June 3. A coupon of 1.6 percent or 1.7 percent is unattractive, Sakurai said.

The prior sale drew bids worth 2.09 times the amount on offer, compared with a so-called bid-to-cover ratio of 2.46 at the May sale. Last year's average ratio was 3.05 times.

The Markit iTraxx Japan index rose 2 basis points to 137.5 basis points in Tokyo, according to BNP Paribas. The benchmark of 50 investment-grade Japanese companies, including All Nippon Airways Co. and Japan Tobacco Inc., increases as investors' perceptions of credit quality deteriorate.

The difference in yields on three-month government bills and the Tokyo interbank offered rate, the so-called TED spread, held at 28 basis points, the most since March 27.

To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.

Last Updated: July 2, 2008 03:51 EDT