EURO GOVT-German Bunds extend slide before auction

Wed Jun 13, 2012 4:31am EDT

Related Topics

* German bonds extend selloff, multiple factors cited

* Bund auction demand still seen solid as Spain risks remain

* Spanish yields stabilise, test of 7 pct seen likely

By William James

LONDON, June 13 (Reuters) - German bond prices tumbled on Wednesday, extending a steep fall seen the previous day, though traders expected them eventually to rebound with markets still fixated on Spain's elevated bond yields and Greek election risks.

The pressure remains on Spain after a 100 billion euro bank rescue plan sparked wider concerns over whether Spanish government bonds would be pushed down the pecking order for repayment by the new debt, and whether Madrid could continue borrowing at affordable rates.

Bund futures fell to 141.54, 94 ticks lower versus Tuesday's market settlement and adding to losses made in after-hours trading.

Market participants cited a range of factors behind the fall in Bunds that has seen 10-year German yields, which earlier this month hit record lows as investors sought shelter in the euro zone's least risky debt, rise nearly 20 basis points in under two days to their highest since late May.

"There isn't a clear cut explanation... I would say there is some profit taking and thinking that there may be a (policy) reaction after the Greek elections," said Achilleas Georgolopoulos, strategist at Lloyds Bank in London.

Greek elections on Sunday could hold the key to its future in the euro zone. If parties opposed to the conditions of the country's life-support bailout win power Greece may ultimately leave the currency bloc, which could stir policymaker into action to prevent contagion and may cool demand for safe-haven Bunds.

An influx of highly-rated bond supply from Austria, the Netherlands and the euro zone's EFSF rescue fund this week has offered higher-yielding alternatives to Bunds. A 10-year German debt sale later in the day also generated some pre-auction selling as dealer made room for the new bonds, analysts said.

Traders also pointed to changes in Danish pension fund rules as an additional technical factor reducing demand for longer-dated German debt.

Some said the rising cost of shoring up the euro zone was having a negative impact on Germany's creditworthiness. German bonds have suffered more heavily than higher-yielding U.S. debt in the past two session, narrowing the 10-year yield gap by 15 bps to 17 bps - its narrowest since early March.

However, 10-year German bond yields remain at an extremely low 1.47 percent. The 5 billion euro bond sale due after 0930 GMT was not expected to be short of bidders looking for a low-risk and liquid asset.

"While Germany's creditworthiness is certainly increasingly affected by further bailouts for the periphery, we do not subscribe to another 'failed' auction and firmly re-iterate our view that Bunds still belong to the safest and most liquid assets globally," Commerzbank strategists said in a note.

SPAIN STEADY, FOR NOW

In early trade on Wednesday 10-year Spanish bond yields were slightly lower at 6.69 percent, around 17 bps below Tuesday's peaks.

However, after hitting euro-era highs of 6.86 percent on Tuesday yields were seen rising further to test the 7 percent level - viewed by many as the point at which borrowing from capital markets becomes unaffordable in the long term.

"Above 7 percent and it gets very messy for Spain," a second trader said.

Italy, seen as the next euro zone country in the market's sights after Spain, was also in focus before debt sales on Thursday, at which the sovereign was expected to pay a high cost.

Italian yields eased 7.5 bps to 6.09 percent on Wednesday, but have risen more 30 basis points this week as worries about Spain have escalated.

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