LONDON: German bond yields tracked their US counterparts lower on Tuesday but remained near their highest level since March 2012 as investors bet the Federal Reserve would start slowing bond purchases as early as next month.
The Fed's July meeting minutes are released on Wednesday and could reinforce expectations that the central bank will begin curbing monetary stimulus in September.
The expectation of tapering and better data in the euro zone saw German yields post their biggest weekly rise since June last week. But analysts said the rally could only be fuelled by weak economic releases and, with a thin data calendar, they were unlikely this week.
"I think the sell-off is running out of steam at the moment but conditions for a significant rally are not there," said Patrick Jacq, European rate strategist at BNP Paribas.
Ten-year German Bund yields were 3.8 basis points lower at 1.86 percent having risen as far as 1.924 percent on Monday - its highest since March 2012.
Jacq said yields would struggle to break through 1.80-1.85 percent in the near term.
"My gut feel is that the tapering is in the market. If they taper in September, I doubt that it would be a huge shocker to the market. The preparation has been quite brutal," a trader said.
He referred to the sharp sell-off in US Treasuries in particular, which took 10-year bond yields as high as 2.90 percent on Monday - its highest since July 2011. They were last down 7.4 basis points at 2.81 percent.
"We are seeing a bit of a technical bounce, no more than that. Ten-year Treasuries have bounced off 2.90 and that's giving some support to Bunds this morning," said Nick Stamenkovic, bond strategist at RIA Capital Markets.
The improved euro zone data, combined with a dearth of supply in August, has also led to a sharp fall in the premium offered by lower-rated debt over German Bunds.
After hitting its lowest level in two years, the 10-year Spanish/German yield spread was 4 basis points wider on the day at 257 bps and the Italian equivalent was 5 bps wider at 244 bps.
"They have continued to tighten in the face of what has been the lack of supply in August," the trader said.
"Now that we are approaching the period where people are going to start thinking about the resumption of supply, I think you probably need further good news to sustain or continue to drive spread narrowing".
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