October 17, 2013 / 4:59 PM / 4 years ago

Core euro zone bonds rise as U.S. debt deal seen as "stop-gap"

* Worry over temporary nature of deal, Fed tapering delay seen

* Strong Spanish sale shows demand for country’s debt still strong

* France also sees firm demand at auction

By Emelia Sithole-Matarise and Ana Nicolaci da Costa

LONDON, Oct 17 (Reuters) - High-rated euro zone debt rose on Thursday as market players viewed an 11th-hour deal to avoid a U.S. debt default as a “stop-gap” measure likely to delay moves by the Federal Reserve to scale back bond purchases.

The overnight deal fully funds the U.S. government only until Jan. 15 and raises the debt ceiling until Feb. 7. Investors worry that fundamental differences between Republicans and Democrats over spending and deficits herald another bitter budget fight and government shutdown early next year.

Those concerns were reflected in costs of insuring against a U.S. default. One-year credit default swaps were down more than 20 basis points from last week’s highs, but they remain higher than five-year rates, suggesting “tail-risk” has yet to be fully priced out.

It is normally costlier to buy longer-term credit protection.

German Bund futures jumped 77 ticks to settle at 139.68, pushing 10-year German yields 7 basis points down to 1.87 percent, off their highest in almost a month.

“The fact that this is a stop-gap solution has had a big impact on what people think the Fed is going to do,” said Lyn Graham-Taylor, a strategist at Rabobank. “Therefore tapering expectations have been pushed back to March 2014 (from December 2013), so the bid for government bonds makes sense.”

Word that new U.S. jobless claims last week declined by less than economists had estimated was supportive for core euro zone bonds as they tracked U.S. Treasuries higher, since the weaker the U.S. employment picture, the less likely the Fed would be to become less accommodating.

Among higher-yielding bonds, continuing healthy demand for Spanish paper extended to a strong auction at which the Madrid treasury sold 2.54 billion euros of debt - above the targeted amount as medium-term debt costs fell.

Analysts said the U.S. backdrop was supportive but also noted that recent demand for euro zone peripheral debt has generally been driven by improved economic forecasts and hopes for further liquidity from the European Central Bank.

FRENCH BONDS POPULAR

Other higher-rated euro zone debt also rose, as France saw strong demand for its bonds at two auctions.

The euro zone’s second-largest economy has been steadily attracting good demand for its bonds despite sluggish growth and delays in reaching its deficit and debt targets, as it offers better returns than Germany.

French 10-year government bond yields were down 5 basis points at 2.39 percent. Equivalent Dutch and Austrian yields were lower by 2.24 percent and 2.27 percent respectively.

In Madrid, there was strong demand for the three-year and five-year bonds on offer, with the shorter yield falling to its lowest point since April 2010 and the longer one to its lowest rate since it was first sold in July.

In the secondary market, Spanish yields were flat at 4.30 percent while the Italian equivalents were 4 bps lower at 4.20 percent /

“Overall, it’s a fairly solid auction but also we have to keep in mind that it’s not a huge surprise, because the auction size was small in the first place and we had a budget deal in the U.S. so some positive momentum here for sentiment,” Michael Leister, senior interest rate strategist Commerzbank, said.

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