LONDON: German Bund yields rose and the borrowing costs of the euro zone's most indebted countries dropped on Monday after China's central bank fixed the yuan stronger, easing some of the recent worries about devaluation.
Stress indicators in bank-to-bank lending markets eased as market concerns subsided that Chinese currency weakness would spread growth-crippling deflation across the developed world.
Spot yuan jumped more than 1 percent to 6.4900 per dollar, its firmest this year, after the People's Bank of China set its daily midpoint 0.3 percent stronger. The head of the bank was quoted as saying speculators should not be allowed to dominate market sentiment.
German 10-year Bund yields rose 3 basis points to 0.29 percent as investors shifted to riskier assets such as stocks and higher-yielding debt.
"Safe-haven flows have unwound somewhat, but I don't think the worst is over," said RIA Capital Markets bond strategist Nick Stamenkovic.
"We had a very strong statement from the Chinese authorities signalling they are committed to a stable currency and that's helped sentiment. But there's still a lingering suspicion among investors that they might still devalue the yuan going forward."
Stamenkovic said the underlying mood in the market remained fragile due to ongoing worries about the banking sector, the uncertain outlook for the Chinese economy, as well as worries about the United States after its first interest rate in almost a decade last December.
Contributing to the rise in German yields, oil prices kept most of their 10 percent gains from Friday, when talk arose again that the Organisation of the Petroleum Exporting Countries might finally agree to cut output.
Yields on Spanish, Italian and Portuguese yields fell 4 to 7 basis points.
Ten-year Portuguese yields stood at 3.55 percent, almost a full percentage point below their high last week, when markets singled out the country as the euro zone's weak link, in a throwback to the region's 2011-2012 debt crisis
In Italy, the treasury said the European Central Bank was in talks with the government about buying bundles of bad loans as part of its asset-purchase programme and accepting them as collateral from banks in return for cash.
The move could help a recently approved Italian scheme aimed at helping banks to offload some of their 200 billion euros ($225 billion) of bad debt and free resources for new loans.
Worries about banks have been one of the main reasons for the selling pressure on southern European debt in recent weeks. Stress indicators in bank-to-bank lending, derived from the difference between overnight rates on a forward curve and longer-term Libor rates, were now recovering from their highest levels in more than a year.
The euro forward BOR/OIS contract starting in March and ending in June narrowed to just under 14 basis points from a high of 17 bps last week. At the height of the euro zone crisis, the same spread was almost 150 bps, and in the aftermath of the Lehman Brothers collapse in 2008 the spread was almost 230 bps.
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