LONDON Treasuries rose on Wednesday as fears over the prospect of an unruly Greek default soured demand for riskier assets such as equities, fueling a renewed flight to quality.
Concerns that the European Central Bank could be forced to take losses on its Greek debt holdings, compromising its ability to prevent the bigger economies of Italy and Spain from being sucked into the debt crisis, offset positive data on Germany's economic outlook.
IMF Managing Director Christine Lagarde said Greece's public sector creditors may need to take part in Greece's debt restructuring if writedowns negotiated with private sector bondholders are not enough to make its debt sustainable.
This could include the ECB, which is estimated to have bought about 40 billion euros of Greek debt since May 2010 in an effort to stem the debt crisis.
Italian and Spanish government bond yields resumed their rise, while European equities extended losses, with the pan-European FTEurofirst 300 index .FTEU3 down almost 1 percent on the day.
"There've been a couple of negative stories about Greece and so stocks are coming off and (Italian) BTPs are getting hit and that's supporting Bunds and Treasuries," a trader said.
U.S. T-note futures were up 5/32 on the day at 130-8/32 while benchmark 10-year notes yielded 2.04 percent, down two basis points from late New York levels.
Treasuries traded broadly in line with German bonds, with the 10-year T-note yield premium over Bunds little changed on the day around seven basis points.
Investors were also wary of being caught short going into the U.S. Federal Reserve's policy decisions later in the day after a two-day meeting, trader said.
The U.S. central bank will publish policymakers' individual forecasts for the path of overnight rates, including their views on when the first rate hike will come. The new rate projections are expected to show that most Fed officials see no rise in rates until 2014.
The Fed may also announce an agreed target for inflation, which would likely be in a range of 1.7 to 2 percent that the majority of Fed officials have already said is desirable.
"There seems to be a shared feeling among economists and market participants that the projections will reveal that FOMC members see the first rate hike well beyond mid-2013, probably mid-2014.
"Market may not be pricing in this bullish feeling to the full...so the removal of these uncertainties will make the short end of the curve flatten further," said Alessandro Mercuri, a strategist at Lloyds.
(Reporting by Emelia Sithole-Matarise)