March 14, 2012 / 5:43 PM / 5 years ago

EURO GOVT-Better U.S. outlook sends German yields to 3-wk highs

* German Bunds weak as Fed, stress tests fuel equities rally
    * German 10-year yields could rise to 2 pct in coming days
    * Italian yields slip after strong bond auction


    By Marius Zaharia and Emelia Sithole-Matarise	
    LONDON, March 14 (Reuters) - German 10-year bond
yields spiked to a three-week high on Wednesday and could soon
retest this year's 2 percent peak after the U.S. Federal Reserve
sounded a less downbeat note on growth and most U.S. banks
passed their annual stress test.	
    Strong demand at a 6 billion euro auction of Italian debt
from cash-rich banks, which drove Rome's three-year borrowing
costs to a near-17 month low, also dulled the allure of German
benchmarks. 	
    German Bund prices extended the previous day's losses
triggered by upbeat economic data after the Fed said that it
expected "moderate" growth over coming quarters along with a
gradual decline in the unemployment rate. 	
    "Equities are hitting new highs, the sentiment has improved
so it makes sense for Bunds to catch up with the U.S. eventually
if the U.S. remains where it is," one trader said. "It's
certainly possible to see yields above 2 percent."	
    German 10-year yields jumped 13 basis points
to 1.95 percent, its highest since Feb. 23. Bund yields remain
almost 30 bps below U.S. T-notes and some 40 bps
below UK Gilts.	
    The June Bund future fell 140 ticks to 136.84, its
lowest since Feb. 22. Selling in the contract accelerated after
stop levels were triggered around 137.40, according to traders.	
    With European equities hitting new 2012 highs and the risk
of an imminent unruly Greek default averted, Bunds looked
vulnerable to further losses, prompting Commerzbank strategists
to maintain tactical short positions on the Bund.	
    But the depth of problems the euro zone still faces should
prevent Bund yields from rising much above 2 percent in the
longer run.	
    "I would be relatively neutral as from a fundamental
perspective growth in Europe is expected to be subdued, a
recession (is likely)... and also there are still some
disinflationary forces around like the private sector
deleveraging," said Michiel de Bruin, who manages 25 billion
euros as head of euro government bonds at F&C Netherlands.SPAIN VS ITALY	
    Italian government bond yields fell across the curve
, outperforming other peripheral euro zone
issuers, after strong demand at its bond auctions - a five
billion euro BTP maturing March 2015 and 1 billion euros of an
off-the-run 2019 bond.	
    BTP futures rose to 106.69 from 106.30 before the
auction while the Italian 10-year yield was down 5 bps on the
day at 4.86 percent, outpacing the Spanish equivalent which was
up 2 bps at 5.17 percent.	
    Spain has massively underperformed Italy this year and
analysts think Thursday's auction of three-, four- and five-year
debt will probably prove weaker than Italy's. 	
    Spanish 10-year bonds now yield over 30 bps more than their
Italian counterparts, after trading almost 200 bps lower at the
start of the year, reflecting the switch in market attention to
Spain's poor economic data and its 2011 budget goal miss.	
    Nevertheless, domestic banks are expected to take advantage
of the relatively higher yields and take down the supply in a
smooth fashion.	
    "The underperformance of Spain should prove to be supportive
of what in any event will be small auctions with a maximum size
of 3.5 billion euros compared to recent maximum targets of
around 4.5 billion euros," Barclays Capital rate strategist Huw
Worthington said.	
   Credit Agricole strategists saw good value in the new Italian
three-year issue, and recommend switching out of Spain's Jan.
2015 bond which has not been tapped since last August.	
   "There is a 25 bps pick-up from the Spanish to the Italian
issue, making this possibly the best value Spain-Italy switch at
this time. At anything above 10 bps, the switch makes sense and
should be held medium term," they said in a note.

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