* Weak French PMI data sends Bunds to a three-week high
* Upbeat U.S. data prompts investors to take profit
* Hunt-for-yield trade prevails
By Ana Nicolaci da Costa and William James
LONDON, Jan 24 (Reuters) - German Bund futures reversed a rally and ended lower on Thursday as business surveys showing tentative signs of strength in some major economies offset pockets of weakness in euro zone data.
German bond prices rallied to three-week highs in early trading as French business activity numbers fell short of expectations. But above-forecast survey results for Germany’s private sector dented enthusiasm for the perceived safety of Bunds and upbeat U.S. data reversed the trend.
U.S. factory activity grew the most in nearly two years in January and the number of new claims for jobless benefits fell to a five-year low last week.
“It has been a roller coaster ride here,” David Schnautz, interest rate strategist at Commerzbank said. “The leg lower (in the Bund) mirrored pretty closely when the U.S. jobless claims came in much lower than expected.”
German Bund futures made a settlement close of 143.20, down 39 ticks on the day, having risen earlier as far as 144.07 - its highest in three weeks.
German private sector activity jumped to its highest level in a year in January, while French data pointed to a possible recession in the euro zone’s second-biggest economy.
The data underlined the divergence among the region’s largest economies and that recovery is vulnerable if Germany is the only source of growth. Spanish figures showed another record high unemployment rate and a rising tide of bad bank loans.
Even so, ten-year Spanish government bond yields were 5.1 basis points lower at 5.03 percent and the Italian equivalent was 3.1 bps lower at 4.16 percent.
A string of heavily oversubscribed debt sales by peripheral states over the last two weeks has reinforced confidence that funding problems for the region’s weaker states have eased.
However, some market participants remain sceptical that the demand is based on improving fundamentals, instead highlighting the huge amount of cash made available by loose central bank policy that needs to be put to work to generate returns.
“The good news for peripherals relies on expectations - we expect the election result in Italy will be market friendly, we expect that Portugal and Spain will be in good condition, and the situation in the euro zone will normalise,” BNP Paribas strategist Patrick Jacq said.
“But this is only expectation. We need to see some materialisation of that.”
Although the rate of decline in the euro zone private sector slowed by more than expected, the growth that the region’s weaker economies like Spain and Italy need to turn around their finances and start reducing debt remains some way off.
Investec analyst Elisabeth Afseth said that over the longer term it would be hard to reconcile the enthusiasm for lower-rated debt issued by peripheral states with the weak growth picture.
But for now, investors are reluctant to play against a hunt-for-yield trade which has been mainly made possible by the European Central Bank’s pledge to support the bond markets of struggling sovereigns that seek help.
Against that backdrop, Commerzbank’s Schnautz recommends buying Belgian bonds against those of other higher-rated sovereigns.
“What still seems to be working very well is our recommendation of Belgium versus the better credits,” he added. “The hunt for yields is still going on... to have an overweight on Belgium still seems to be one of the best risk-reward trades.”
Ten-year Belgian bonds yielded 2.22 percent, compared with 2.17 percent offered by France’s equivalent and much higher than Germany’s 1.51 percent.