* Upcoming peripheral bond supply spooks investors
* Portuguese, Spanish debt underperforms German paper
* Bunds flat as investors anticipate strong U.S. jobs report
By William James
LONDON, Jan 7 (Reuters) - Higher-yielding euro zone bonds suffered on Friday as upcoming debt sales from the region's peripheral states unsettled investors, though safe-haven gains for German debt were limited ahead of key U.S. jobs data.
Yield spreads against Bunds widened sharply for peripheral euro zone borrowers following Thursday's announcement of a Portuguese bond sale. [ID:nLIS002542] Portugal, Spain and Italy are now all scheduled to hold their first bond auctions of the new year next week.
"With the euro zone's three weakest issuers coming to market next week in the space of two days it ramps up the tension, said Orlando Green, strategist at Credit Agricole in London.
"There has to be some repricing to get (the auctions) done, but will it be enough? That depends on investor appetite."
The Bund future FGBLc1 was 4 ticks lower at 125.69, erasing earlier gains as investors adjusted their positions in anticipation of a strong U.S. employment report. December's non-farm payrolls data is due for release at 1330 GMT.
Greece and then Ireland were frozen out of debt markets and forced to seek bailouts from the European Union/IMF in 2010 as a result of large budget deficits and banking sector weakness.
Consequently, debt supply from other struggling euro zone states is set to be a key driver of sentiment in the coming months, with Portugal seen as the next most likely to seek aid.
"It's pretty concerning the way the periphery is trading at the moment, and we haven't even started supply yet... with Spain and Italy also selling (next week) it's going to be pretty difficult times," a trader said.
Ten-year yield spreads against the German benchmark were wider across the region. The Portuguese/German PT10YT=TWEB spread was last at 438 basis points, out 18 bps on the day.
Portuguese debt has underperformed Italian bonds IT10YT=TWEB -- considered the benchmark among peripheral issuers -- by around 45 basis points this year.
European Union proposals to force those who lend to banks to bear big losses if they fail added to banking sector worries at the heart of concerns surrounding peripheral debt. [nLDE7051NI]
The Belgian/German BE10YT=TWEB spread hit its widest since early December, up 8 bps to 126 bps, as dimming prospects the country will form a government fuelled concerns about Belgium's ability to tackle its large public debt. [ID:nWEA0053]
The cost of insuring Belgian sovereign debt against default hit a record high 255 bps, drawing level with current Italian credit default swaps prices.[ID:nLDE7060GE]
PAYROLLS POSITIONING A well-above-forecast U.S ADP jobs report earlier in the week has raised market expectations that non-farm payrolls will beat forecasts. That would be good news for the U.S. economy and stoke investor appetite for riskier assets such as stocks, but could weigh on defensive instruments like bonds. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
U.S. payrolls preview graphic r.reuters.com/quv94r ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
But with some players saying a strong number is already priced into Bunds, the door may be open for a rally if the data comes in below forecast. It also reduces the risk of a sharp sell-off on a strong report.
The 10-year German bond yield DE10YT=TWEB was 2.925 percent, up 1 bps, while the two-year Schatz yield DE2YT=TWEB was 1.4 bps higher at 0.904 percent.
"Actual market expectations should now certainly be much higher... increasing the threshold for a bond market-negative surprise," said Commerzbank strategist Marcel Bross in a note.
The median of forecasts from analysts polled by Reuters was for employers to have added 175,000 jobs in December, well up from 39,000 new jobs in November.[US/O] (Graphic by Stephen Culp)