German yields rise as U.S. Senate strikes last-minute deal
* Bund yields highest in nearly a month on U.S. deal bets
* German two-year bond auction strongly bid
* Bund reaction to Senate deal muted in after-hour trading
By Ana Nicolaci da Costa and Marius Zaharia
LONDON, Oct 16 (Reuters) - German yields rose to their highest levels in almost a month on Wednesday, as bets the United States would avoid default were reinforced after the Senate agreed to raise the debt limit and reopen the government.
U.S. Senate Democratic leader Harry Reid and Senate Republican leader Mitch McConnell announced a bipartisan deal, which will avoid a U.S. default. The move is expected to be approved later in the day by the Republican-led House of Representatives.
"It might bring some pain relief but it will not be a multi-year grand fiscal bargain," Societe Generale rate strategist Ciaran O'Hagan said before the announcement.
Bund futures, which usually find support in times of uncertainty as they are considered low-risk assets, settled 33 ticks lower at 138.91 before the deal was announced. Cash 10-year German yields hit their highest in nearly a month at 1.945 percent earlier.
Interest rates on U.S. Treasury bills due in late October through early November extended their earlier decline on Wednesday after the announcement.
"It's not the optimal deal ... and it must have been somewhere in the price that we were going to get a solution, so that's why we've had the slightly muted response so far," one trader said.
The deal would extend U.S. borrowing authority until Feb. 7, although the Treasury Department would have tools to temporarily extend its borrowing capacity beyond that date if Congress failed to act early next year. It would also fund government agencies until Jan. 15.
SHAKY SHORT-TERM DEBT
While there was no sign of panic in global financial markets in broad terms, some areas were still showing caution.
Yields on Treasury bills maturing on Nov. 29 were at 0.12 percent, off a 0.26 percent high on Friday but still higher than 0.01 percent in late September.
One-month Treasury bills that come due on Nov. 7 yielded 0.22 percent. That was off 0.36 percent last week - their highest since the 2008 financial crisis - but still above just 0.03 percent at the end of last month.
The fact that Treasury bill yields had not fully retraced their recent rise suggested investors remained nervous.
Investors earlier used a two-year German bond auction as an opportunity to hedge against the so-called "tail risk" - a tiny possibility of a U.S. default.
Germany sold 4.24 billion euros of bonds at prices above those in the secondary market as demand measured by the bid/cover ratio rose to 2.3 from 1.6 at a previous auction.
"This is a strong auction result, with it likely having benefited from safe haven-type demand on the back of the uncertainty about the political situation in the United States," Rabobank rate strategist Lyn Graham-Taylor said.
Other euro zone bonds were broadly steady.
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