LONDON: German Bund yields dipped further into uncharted territory on Friday, hitting fresh lows for the third consecutive day, as investors turned cautious on increased tensions in the Middle East and Ukraine.
The US authorised air strikes on Iraq, Palestinian militants resumed rocket fire into Israel and NATO urged Russia to pull back from the brink of war with Ukraine.
"Geopolitics are ruling at the moment and 'risk-off' is
dominating the trading pattern," said Rainer Guntermann, a rates strategist at Commerzbank.
German 10-year yields fell 4 basis points to 1.04 percent, with strategists predicting a flight to safe-haven assets could send them as low as 1.00 percent.
US President Barack Obama said on Thursday he had authorised US air strikes to blunt the onslaught of Islamist militants in northern Iraq, and began airdrops of supplies to besieged religious minorities to prevent a "potential act of genocide".
Palestinian militants in the Gaza Strip resumed rocket fire into Israel after Egyptian-mediated talks in Cairo failed to extend a 72-hour truce in a month-long war.
In the latest episode in the Ukrainian conflict, NATO on Thursday urged Russia not to invade its neighbour after detecting a build-up of troops on the border.
The European Central Bank warned on Thursday that the conflict in Ukraine posed a serious risk to the euro zone economy.
PERIPHERY PRESSURE
Strategists at Barclays told clients it had reduced exposure to Spain and Italy, expecting their yield premium over Germany - the euro zone benchmark - to continue to rise.
The premium Italy pays to borrow 10-year money over Germany rose to 190 bp in early trading on Friday, its highest in over five months. The equivalent for Spanish bonds hit 165 bps, a two-and-a-half month high.
But the initial pressure on the periphery abated somewhat, particularly in Spain, where 10-year yields reversed early losses to trade 2 bp tighter at 2.59 percent.
Brokers said some domestic buying of Spanish 10-year bonds had prompted the turnaround.
Italian equivalents were 2 bp higher at 2.87 percent, having climbed as high as 2.91 percent earlier.
Banks including RBS and Commerzbank have predicted the premiums for both countries to be around 100 bps by the end of the year, squeezed by the European Central Bank's ultra-loose monetary policy.
Michael Michaelides, a rates strategist at RBS, argued that, as Bund yields drop further, the relative value in Spanish and Italian bonds will be too hard to resist.
"If you are now going to double your yield by buying a bit of periphery, that is a lot more significant that just getting a bit of additional carry, as you did at the start of the year," he said.
"That's why we think that ultimately investors will get crowded into the periphery trade," he said.
Portuguese 10-year yields rose 1 bp to 3.94 percent while Greek equivalents rose 9 bp to 6.61 percent . Traders said that price action was exaggerated by low trading volumes, particularly in illiquid Greek bonds.
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