* Last-minute U.S. budget deal hurts Bunds, U.S. Treasuries
* Italian 10-yr yields at lowest in just over two years
* German two-year debt sale covered but demand slips
* Focus to turn to U.S. debt ceiling talks in coming weeks
By Marius Zaharia and Emelia Sithole-Matarise
LONDON, Jan 2 German Bund yields spiked and
those on riskier euro zone bonds plunged on Wednesday after U.S.
lawmakers approved a deal preventing a fiscal crunch that could
have pushed 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, avoiding $600 billion in broad-based automatic tax
hikes and spending cuts.
The last-minute deal, which fulfills President Barack
Obama's re-election pledge, spurred a rally in riskier assets
such as equities and peripheral euro zone debt, and the
perceived safest assets, such as Bunds and U.S. Treasuries.
Bund futures were last 160 ticks lower on the day
at 144.04, while German 10-year cash yields were
13.5 basis points higher at 1.433 percent.
"Markets are celebrating the events in the U.S.," said Niels
From, chief analyst at Nordea. "But I don't think it (the
sell-off in Bunds) will go very far. As soon as we see Bunds
getting cheaper buyers come back to the market."
Concerns over the global economy and the euro zone debt
crisis would ensure some of the vast sums of cash made available
by central banks would find its way into safe-haven assets, he
Highlighting the underlying demand for German debt, a nudge
into positive territory for yields on two-year bonds -- seen as
among the safest investment instruments in the world -- was
enough to ensure Germany could sell 4.15 billion euros of the
debt in the euro zone's first auction of the year.
Demand was weaker than at previous auctions, but the sale
was comfortably covered.
"It was not the best day to auction German bonds but the
result was not that poor," said Patrick Jacq, a rate strategist
at BNP Paribas.
The selling pressure in Bund markets could soon fade as
focus turns to fresh talks on raising the U.S. debt ceiling to
allow the government to continue borrowing, analysts said.
"This will be another debate for the next few weeks, which
could possibly be supportive for Bunds," Commerzbank rate
strategist Rainer Guntermann said.
Nordea's From said a clear break above 1.46 percent in
10-year yields, a level reached on several occasions since early
November, would be "difficult" to achieve in the absence of
further positive developments on the debt crisis and global
Higher-yielding euro zone debt rallied on Wednesday, with
Italian 10-year yields falling 23 basis points to
4.273 percent, their lowest in more than two years. Equivalent
Spanish yields dropped 22 bps to 5.05 percent.
Debt issued by the two countries has rallied for several
months on the back of a new European Central Bank bond buying
programme that could be activated later this year.
However, many analysts caution the rally may have gone too
far and markets may use the February elections in Italy as an
opportunity to re-assess their stance on peripheral debt.
"The crisis is not over in southern Europe," From said.