* Last-minute U.S. budget deal cools demand for low risk
* Italian 10-yr yields at lowest in just over 2 years
* German 2-yr debt sale covered but demand weaker vs pvs
* Focus turning to U.S. debt ceiling talks in coming weeks
By Emelia Sithole-Matarise
LONDON, Jan 2 German Bunds dropped on Wednesday
after U.S. lawmakers approved a deal preventing a round of
automatic tax hikes and spending cuts that had threatened to tip
the world's largest economy into recession.
The Republican-controlled House of Representatives approved
late on Tuesday a bill that will raise taxes on top U.S.
earners, fulfilling President Barack Obama's re-election pledge
and avoiding a 'fiscal cliff' of $600 billion in broad-based tax
hikes and spending cuts.
The last minute deal spurred a rally in riskier assets such
as equities and peripheral euro zone debt, driving Italian
10-year yields to their lowest levels in just over
Although Germany managed to sell 4.15 billion euro of
two-year bonds, demand was weaker than at a previous auction of
the zero interest rate-bearing debt.
"The fact that the U.S. made an agreement to avoid the
fiscal cliff was a trigger for some risk appetite so it was not
the best day to auction German bonds but the result was not that
poor," said Patrick Jacq, a strategist at BNP Paribas.
The Bund future was last 153 ticks down on the day
at 144.11, near a 1-1/2 week low while cash 10-year Bunds
yielded 1.43 percent, up 13 basis points.
Bunds slightly underperformed U.S. Treasuries, with the
10-year T-note yielding 39 bps over their German counterparts
versus 42 bps in late European trade on Monday. U.S. and
European markets were shut for New Year on Tuesday.
Strategists and some traders said Treasuries could resume
their underperformance of Bunds when the U.S. session gets
The sell-off in safe-haven U.S. and German bonds was,
however, likely to fizzle out in coming weeks as focus turns to
fresh talks on raising the U.S. debt ceiling to allow the
government to continue borrowing, traders and strategists said.
"Treasuries could even underperform (Bunds today)," said
Rainer Guntermann, a strategist at Commerzbank.
"But we also have the follow-up debate on the debt ceiling
which we are bumping into in February and this will be another
debate for the next few weeks which could possibly be supportive
Among lower-rated euro zone debt, Italian 10-year bond
yields were last 18 bps down at 4.33 percent,
having hit a trough of 4.312 percent earlier, the lowest since
November 2010. The Spanish equivalent was 13 bps
lower at 5.14 percent.
"The (U.S.) deal aids risk markets and should help to
stabilise semi-core and periphery markets this week but supply
is quickly likely to regain the focus and we expect some
tactical widening into issuance, but ultimately expect that this
issuance will be taken down well in January," RBS strategists
said in a note.