EURO GOVT-Euro zone debt seen stabilising before Fed meeting
* Trading light before Fed meeting later this week
* Markets looking for clarity on Fed stimulus outlook
* Greek tensions briefly send Bunds to one-week highs
By Emelia Sithole-Matarise and Marius Zaharia
LONDON, June 17 (Reuters) - German debt dipped and lower-rated euro zone bonds were stable or stronger on Monday, although moves were expected to be limited before the U.S. Federal Reserve's policy decision later this week.
Traders reported light trading volumes as some investors made their final adjustments before the Fed meeting by buying back into higher-yielding assets cheapened by a recent sell-off.
Concern the Fed could start reducing its massive stimulus has rocked financial markets in the last few weeks, driving lower-rated euro zone borrowing costs away from multi-year lows and safe-haven German yields to their highest in three months.
Some of those moves reversed on Friday after data showed the U.S. economic recovery may not be strong enough to warrant a radical change in the Fed's accommodative policy.
"Markets are coming to terms with the idea that tapering off (liquidity stimulus) does not have anything to do with higher rates," Commerzbank rate strategist David Schnautz said.
Even if the Fed announces a slowdown in the pace of asset purchases, it would do so in a way that would allow markets to "stay calm and not interpret the move as the beginning of the end (for monetary stimulus)," he added.
Italian 10-year yields were last 2 basis points down on the day at 4.27 percent, while equivalent Irish and Portuguese yields were also 2-4 bps lower at 3.92 percent and 6.27 percent, respectively.
Spanish 10-year yields were 1 bps higher on the day at 4.59 percent, underperforming peers ahead of debt sales of up to 4 billion euros on Thursday.
"After the big flush-out of carry trades at the beginning of last week the market feels a little bit better going into the Fed," one trader said. Carry trades involve taking cheap loans to buy assets which offer a higher return.
Some in the market saw opportunities in what they said were oversold peripheral euro zone bonds to lock in higher returns than those offered by low-risk German debt.
RIA Capital Markets strategist Nick Stamenkovic recommended buy-and-hold investors purchase Portugal's June 2019 bonds , yields on which have jumped by 120 bps to about 5.8 percent in the past three weeks - a premium of more than 5 percentage points over equivalent German debt.
At the euro zone's core, German Bund futures were 9 ticks lower at 143.77. Volumes by 1500 GMT were at about 473,000 lots, compared with a daily average of about 800,000 in previous sessions in June.
They briefly hit a one-week high of 143.99 early in the session with traders citing concerns that tensions in Greece's ruling coalition could prompt an early election.
A year after a general election brought Prime Minister Antonis Samaras and his two leftist allies to power, the three parties have fed fears of hugely disruptive snap polls by refusing to compromise over the closure last week of state broadcaster ERT.
"Greece is coming back like a vampire from beyond the grave," one trader said, adding however that he did not expect large swings before the Fed meeting.
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