December 4, 2012 / 5:16 PM / 5 years ago

EURO GOVT-Peripheral rally loses steam, Bunds underpinned

* Spanish, Italian yields lower but Monday's rally falters
    * German Bunds supported by U.S. budget talks gridlock
    * Peripheral rally may yet have further to run - KBC

    By William James and Emelia Sithole-Matarise
    LONDON, Dec 4 (Reuters) - Recent volatility in euro zone
government bonds eased on Tuesday, leaving yields on both
low-risk and higher-yielding debt slightly lower on the day as
U.S. worries offset a positive mood in the bloc.
    After big gains on Monday the rally in peripheral euro zone
debt, fuelled by optimism that Greece will meet the conditions
necessary to secure its latest bailout tranche, looked to be
running out of steam.
    At the same time, German debt recouped a large part of
Monday's losses as demand for the safety of Bunds remained
intact thanks to U.S policymakers' wrangling over how to avoid
spending cuts and tax hikes seen likely to spark a recession.
    "We've got a 'risk-on' tone in Europe but a macro global
'risk-off' move as people worry about what's going on in the
U.S., and Bunds benefit a bit from the U.S. backdrop," said Lyn
Graham-Taylor, strategist at Rabobank in London.
    German Bund futures settled 23 ticks higher at
142.74, holding within the 141.84-143.48 range established
during November. 
    In the periphery, Italian 10-year yields 
settled 3 basis points lower at 4.42 percent while the Spanish
equivalent was last down 1 bp at 5.26 percent.
    That was only a slight move compared with recent large gains
spurred by the belief that a Greek debt buy-back would be
successful thanks to generous terms announced on Monday, and
would pave the way for Athens to receive aid funds.
    In the previous session Italy's borrowing costs fell to
fresh two-year lows and its 10-year yield premium over Bunds
dropped below 300 bps for the first time since March.
    "We think that the big items such as an imminent bankruptcy
in Greece are off the table. The overall climate is in favour of
investors looking for yield everywhere and so the way of least
resistance is for a narrowing of yield spreads," Piet Lammens, a
strategist at KBC, said.
    Greek bond prices were slightly lower after
Monday's sharp rally, ahead of the results of the bond buyback
due at the end of the week.
    German 10-year yields were down 1.7 bps at
1.39 percent, well within their recent 1.30-1.70 percent trading
range and traders saw little scope for yields to break the top
of that range given concern about congressional gridlock in U.S.
budget talks.
    Investors were doubtful that U.S. lawmakers will reach a
deal in time to avert a recession-inducing fiscal tightening in
the world's biggest economy early next year after the White
House dismissed Republican proposals for steep spending cuts.
    "The fiscal cliff debate rumbles on ... The growth
implications if they don't get something sorted out are fairly
severe and as long as that remains in play, core markets remain
reasonably well supported," a trader said.

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