Bunds lower, focus on ECB 3-year tender

LONDON: Bunds fell on Tuesday, as appetite for other euro zone bonds improved on hopes that banks will borrow a large amount of three-year funds from the ECB later this week and buy high-yielding Spanish and Italian debt.

But many analysts fear the banks may use the funds to roll over their own debt rather then buy government bonds that could eventually cause them mark-to-market losses.

A Reuters poll showed euro zone banks were expected to snap up 250 billion euros in the European Central Bank's first offering of three-year loans on Wednesday, although forecasts ranged from 50 to 450 billion, indicating a high degree of uncertainty.

"The expectations are massive," one trader said. "A higher take-up is going to give the periphery some support, but we're possibly setting ourselves up for a fall. It's not guaranteed that they're going to buy (peripheral bonds)."

At 0709 GMT, Bund futures were 7 ticks lower on the day at 138.32.

For now, markets will focus on the one-week ECB liquidity operation later on Tuesday, in which banks are expected to borrow 250 billion euros compared to 292 billion euros maturing.

"If the allotment is significantly lower, then the market will probably conclude that the borrowing is being rolled into the three-year, thus this would offer more support to the front end," Credit Agricole strategist Peter Chatwell said in a note.

"However we would add a point of caution: reduced usage may also mean that banks are choosing to use the dollar facility, along with an FX swap, to fund euro positions."

He added the Greek and Spanish T-bill auctions later in the day will be closely watched for signs of improved demand.

Despite significant tightening in peripheral spreads over Bunds on Monday, sentiment remained shaky, with a long-lasting solution to the euro zone debt crisis yet to be found.

European policymakers failed on Monday to boost resources at the International Monetary Fund by a targeted 200 billion euros, agreeing to raise 150 billion and leaving doubts about whether the scheme would work.

ECB President Mario Draghi also reiterated that the banks' purchases of sovereign debt were temporary and limited.

"At the end of the day our core view is that we're still in trouble and I don't see any reason for Bunds not to be supported," the trader said.