Bunds slip; record low yields still seen

LONDON (Reuters) - German government bonds slipped on Friday, with ultra-low yields making some investors reluctant to hold the debt, but losses are seen limited as worries the United States could slip back into recession fanned a sell-off in equities.

With funding strains in money markets compounding investor jitters, capital preservation in safe-haven government debt still dominated investors' mindset, some traders said.

Bund futures fell as much as 53 ticks on the day to a session low of 135.22, but quickly pared the losses to last stand at 135.59, down 16 ticks -- barely a third of Thursday's rally.

Cash 10-year Bund yields were up a shade on the day at 2.09 percent, within sight of a record low of 2.028 percent hit on Thursday. They still looked set to test a new low at 2 percent given the slim prospects of an imminent turnaround in sentiment.

"We have for the first time run into a bit of selling from the likes of Asian central banks ... Not huge amounts but definitely a little bit of nervousness about holding bonds at these very low yields," a trader said.

"But equity markets are still very weak so I don't think the Bund future is going to go down far against that backdrop."

European shares extended a sharp sell-off from Thursday, which was exacerbated by the weakest factory activity data from the Philadelphia Federal Reserve in more than two years and helped send German, UK and U.S. 10-year yields to record lows.

The Bund yield is expected to stabilize around 2 percent near-term. Commerzbank chartists said failure to stabilize a decisive break below that level paving the way to 1.90 percent and 1.88 percent -- the 100 percent Fibonacci extension of the June 2009-to-August 2010 decline.

Trading was volatile in holiday-thinned markets with some traders saying any dip in prices was attracting some buying.

"With the negative sentiment stemming from the equity universe, there is still potential for the Bund future to mark new highs again," Unicredit strategist Kornelius Purps said.

"There are simply too many factors which are of concern for investors, be it the business cycle outlook, be it the dollar funding issue with the ECB ... be it risk that the rescue package for Greece might fail due to these collateral demands, be it the discussion about a transaction tax in Europe."

COLLATERAL RISK

Investors were also anxious about the possible ramifications of Austria, the Netherlands and Slovakia seeking collateral on loans to Greece after Finland secured a commitment, casting doubts on the efficacy of a second bailout package for the country agreed in July.

"The political risk implicit in this unfolding episode are significant," Rabobank strategist Richard McGuire said.

Among these, he said requests for collateral by one or more bailout sponsors could result in an impasse as Greece refuses to pay for assistance or one or more euro zone members refuses to endorse the Finnish deal if they fail to get collateral.

In non-core euro zone debt markets, Italian and Spanish 10-year yields hovered just below 5 percent with traders saying the European Central Bank had bought small amounts of short-dated Italian debt.

(Additional reporting by Ana Nicolaci da Costa)