* Bunds dragged lower by U.S. Treasuries
* Peripheral yields rise after no new action on crisis
* Germany sees poor demand at two-year bond sale
By Emelia Sithole-Matarise and Emily Flitter
LONDON, Dec 8 (Reuters) - German 10-year bond yields rose to a seven-month high on Wednesday, under pressure from a sell-off in U.S. Treasuries, although traders said the move could have gone too far given tensions in debt-laden euro zone states.
The lack of appetite for safe-haven government debt weighed on a sale of German two-year bonds, which failed to draw enough bids to cover the amount on offer for the third auction in a row. For full story see [ID:nLDE6B70YG]
The two-year Schatz yield popped back above 1 percent for the first time in two weeks in the wake of the auction, with the underperformance at the front end of the 2/10-year German curve flattening the curve by 8 basis points to 200 bps.
Yields on bonds across the euro zone also rose, with higher-yielding debt gaining little traction from the retreat in German benchmarks after finance ministers announced no fresh action to resolve the region’s sovereign debt crisis.
“What we are seeing is a capitulation on the part of investors who are saying not even Bunds are safe to be in when the growth picture is looking generally strong,” said Fred Goodwin, a rate strategist at Nomura.
March Bund futures FGBLH1 shed 62 ticks to settle at 124.39. In the cash market, 10-year Bunds yielded 6 basis points more on the day at 3.008 percent, having risen earlier as high as 3.067 percent while the 5-year German bond yield was up 13 bps at 1.977 percent DE5YT=TWEB.
“We may see some short-term consolidation but we took a big level out at 2.8 percent (in 10-year Bund yields) and until we hit 3.08 there’s unlikely to be much respite,” a trader said.
The 3.08 percent level represents the 38 percent retracement of the fall in yields seen since the start of the financial crisis in late 2008.
Benchmark Treasury yields rose close to 3.30 percent, the highest since late June, hit by a proposed extension of tax cuts which should boost U.S. economic growth, increasing inflation fears but potentially reducing the need for an extension of the Federal Reserve’s bond-buying programme.
Treasuries’ underperformance against Bunds this week has almost trebled the 10-year yield spread of U.S. debt over German to 30 basis points. “There’s been for some time now a belief that there wasn’t a great deal of upside for yields, particularly in the U.S. you had quantitative easing,” Goodwin said. “And there was the idea that while Europe is in fiscal crisis it seems almost impossible to see German yields go higher so that led to long positioning.”
For graphic of U.S. and Europe government debt, deficits and bond yields see r.reuters.com/gyb29q
Among euro zone’s weaker sovereign issuers, Portuguese 10-year paper was among the worst performing with yields PT10YT=TWEB up 9 bps at 6.202 percent, leaving the yield gap over Bunds 5 bps wider at 320 bps.
Irish 10-year paper regained some ground with yields on 10-year paper up IE10YT=TWEB, with the spread over the German benchmark 6 bps tighter at 530 bps as Bund yields rose more sharply. Traders also said European Central Bank bond buying remained the main support for those markets.
Bunds have until recently tended to benefit from bond investors dumping weaker euro zone sovereigns in favour of perceived safer German debt but there are worries Berlin will eventually wind up footing the bill for more bailouts.
Analysts cautioned the euro zone crisis was far from over.
“As markets return after the New Year and euro zone...governments start their heavy financing operations for 2011, the euro zone periphery is likely to reemerge as a flashpoint,” Lloyds TSB rate strategists said in a note.
Graphic by Scott Barber, additional reporting by Kirsten Donovan; Editing by Ruth Pitchford