LONDON: German Bund futures were little changed in late trading on Tuesday with markets cautious a day before a ruling by the country's top court which is expected to give the go-ahead to the euro zone rescue fund, albeit with tough conditions.
Germany's Constitutional Court said it would not postpone Wednesday's ruling on the legality of the euro zone's bailout fund despite a new challenge by a lawmaker from Chancellor Angela Merkel's party which threatened to delay proceedings.
Few market players expect the court to rule the fund unconstitutional, but some think the judges could attach tough conditions on any future German aid. .
A negative ruling would complicate European Central Bank plans to buy Spanish and Italian bonds to lower their borrowing costs as countries must first request help from the funds.
"The decision is the sole thing that could blow the whole thing out of the water," said Gary Jenkins, managing director at Swordfish Securities.
"It's unlikely they'll do that but if there's one obstacle that it would be hard to see a way around, that would be it."
German Bund futures were up 6 ticks at a settlement close of 140.38. Ten-year German yields were little changed at 1.51 percent and five-year yields were flat at 0.47 percent.
The backdrop for a German sale of new five-year Bobl will be challenging as the prospect for ECB intervention underpins appetite for risk and if the court ruling, as expected, gives the ESM the green light.
Spanish and Italian yields fell in choppy trading and have become vulnerable to profit-taking given how much has already been priced into those bonds' rally.
Ten-year Spanish government bond yields fell 1.2 basis points to 5.73 percent, while Italian yields shed 7.3 bps to 5.10 percent.
Five year Spanish and Italian yields were slightly lower at 4.42 percent and 3.96 percent respectively.
David Keeble, global head of fixed income strategy, at Credit Agricole expects the court to approve the ESM but said a rejection would drive the premium investors require to hold Spanish and Italian sovereign debt over German counterparts back to all-time highs.
NO MAN'S LAND
Spanish yields have eased sharply since ECB chief Mario Draghi promised in July to do whatever it took to defend the euro -- a fall reinforced by last week's pledge to buy potentially unlimited bonds, under strict conditions.
Where yields go from now is anyone's guess. For them to fall further, analysts say Spain would have to ask for formal help - a precondition for ECB intervention.
But they are unlikely to do so unless the country feels it is losing access to funding, which will only occur if borrowing costs become prohibitive again.
"The trouble is there is no incentive for Spain to take the bailout until the pressure comes on to its bonds... We are sort of in no man's land," Credit Agricole's Keeble said. "That could put the decision of Spain on hold for a bit longer."
Another round of quantitative easing by the Federal Reserve - if it is announced on Thursday - could also buy struggling euro zone sovereigns time by improving appetite for riskier assets.
Higher rated non-German paper were also well bid, with French 10-year yields down 8 basis points at 2.17 percent and Austrian yields 6.7 basis points lower at 1.98 percent.
"We've had quite a lot of buying from central banks and domestics in the five-to-seven year part of the French curve," one trader said.
"If anything we would perhaps argue that France is looking very fully valued at this point."
The Netherlands sold 2 billion euros of 10-year bonds - below the 2.5 billion euro maximum target a day before a parliamentary election, paying its lowest yield this year of just 1.8 percent. Dutch 10-year yields were down 2.5 basis points at 1.86 percent.
"Uncertainties about the outcome of the elections might explain part of the underperformance and, in our view, the trend might continue," she said.
The two pro-European Dutch political parties were in a dead heat, a poll taken on Monday showed.
"The risk for Dutch spreads arises from the scenario that the country will stay without a government for a long period," ING rate strategist Alessandro Giansanti said in a note.
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