By Emelia Sithole-Matarise
LONDON Oct 11 German 10-year yields held near three-week highs on Friday as prospects U.S. politicians will reach a deal to lift the country's debt ceiling, averting a near-term default, lifted stocks at the detriment of safe havens.
Bunds gave up opening gains made after a solid U.S. 30-year bond auction on Wednesday, as a rise in European equities undermined flows into fixed income.
President Barack Obama and Republican leaders appeared ready to end a deadlock over the debt stalemate after a meeting at the White House on Thursday. Talks continued into the night and one senior Republican said an agreement could come on Friday, though hurdles remained.
"Risks if anything are more to the downside for core bonds," said Mathias van der Juegt, a strategist at KBC in Brussels.
"I believe the chances are higher that we might get some short-term agreement on raising the debt ceiling so risks are more to the downside for core bonds because of the U.S. holiday on Monday but I don't expect a big move."
German 10-year yields were at 1.87 percent, their highest in nearly three weeks while U.S. 10-year T-note yields were flat in European trade at 2.68 percent. The Bund future was last 2 ticks up at 139.67
German 10-year yields saw their biggest daily rise in a month on Thursday as signs Washington was inching towards a short-term deal cooled demand for safe havens and lifted riskier assets.
Very short-term U.S. Treasury bill rates have come off peaks hit this week as signs of progress have emerged. Some in the market still saw risks, with a potential deal before Monday's U.S. public holiday seen providing only a brief respite.
"Looking beyond the very short-term, then, this could have negative implications somewhat further down the road," Rabobank strategists said in a note.
"Indeed, while this hard borrowing limit would avoid a potential default scenario in the very near future, there is a risk that, if the Democrats and Republicans cannot make a deal in time, the government will approach another potential default scenario towards the end of November. This might then startle markets again."
The rebound in riskier assets and ebbing political tensions in Italy provide a positive environment for Rome to round up this week's raft of euro zone debt sales with an auction of up to 6 billion euros in bonds.
Italy and Spain took advantage of benign market conditions to sell new seven-year and 31-year bonds respectively on Wednesday, drawing robust demand.
Friday's Italian bond auction is also expected to draw solid interest as Rome capitalises on a relief rally after the government won a confidence vote last week, easing concerns about political instability.
Italian 10-year yields were steady at 4.33 percent while Spanish equivalents were 0.7 bps lower at 4.34 percent.