EURO GOVT-Bunds fall as markets pause for breath, Spain eyed

Tue Feb 5, 2013 4:33am EST

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By Ana Nicolaci da Costa

LONDON, Feb 5 (Reuters) - German Bund futures fell in choppy trading on Tuesday, pausing for breath after returning worries over Italy and Spain spurred the biggest daily rise since December in the previous session.

A good indication of how concerned markets are about a corruption scandal in Spain, which led to calls for Prime Minister Mariano Rajoy to resign, will be demand at a Spanish bond sale on Thursday.

That and worries that an Italian election at the end of the month will generate a government unable or unwilling to continue with fiscal reform have halted progress for the euro zone's lower-rated sovereign bonds.

"We had a very strong rally in peripheral markets, strong spread compression in January which was probably faster than fundamentals were favoring, so we are in a correction - it's not a new trend, it's just a correction," said Patrick Jacq, European rate strategist, at BNP Paribas.

Still, a survey showing euro zone businesses were more optimistic about the future of the region's economy added to a run of hopeful signals for euro zone policymakers. That pulled Bund futures back to a session low of 142.33 but they were still 26 ticks lower on the day at 142.38 at 0920 GMT.

Markit's Eurozone Composite PMI, seen as a good gauge of economic growth, rose in January to a 10-month high of 48.6 from 47.2 in December - an improvement on the preliminary reading of 48.2.

Ten-year Spanish government bond yields were flat at 5.45 percent, while Italian yields were 3 basis points lower at 4.45 percent.

Borrowing costs in Italy and Spain have fallen steadily since ECB President Mario Draghi pledged last July to do whatever it takes to save the euro

The bank's plan for intervention in bond markets that followed that has never been activated, but its existence has deterred investors from selling peripheral bonds.

Piet Lammens, strategist at KBC, said the recovery in Bunds was also just a readjustment after the sell-off it has seen so far this year.

"It tested a downside last week of 141.28, it didn't go through it and then it corrected. The correction may go somewhat more," he said.

"The political uncertainty in Spain and Italy is only a trigger for a correction, it is not something that will change the outlook."

If the contract falls below the 141.28 level, the next big support is 139.73 over the medium-term - a low hit in September of last year, he added.

RELATIVE PLAY

Investors will also look at data from the U.S. vast services sector due later on Tuesday to gauge the monetary policy outlook after recent releases have painted a mostly upbeat picture of the world's largest economy.

A gauge of U.S. business investment plans dropped in December, data showed on Monday, but separate releases last week pointed to steady economic growth, showing job growth and improved manufacturing.

"At the moment, I think there is a kind of decoupling between the U.S. and Europe and therefore I think the Bund can outperform Treasuries," Jacq added.

"This has to do with the economic situation in the U.S. and also the fact that risks are reemerging in Europe, this is offering Bunds stronger support and therefore it makes sense to see an outperformance."

In early European trading, the yield spread between 10-year U.S. Treasuries and the German equivalent stood at 35 basis points, little changed from the previous session but wider than the 29 bps in late European trading on Friday.

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