LONDON: German Bund yields hit new lows across the curve on Friday, with yields on two-year debt briefly turning negative, on fears Spain may need external help to shore up its troubled banking sector as its sovereign financing costs threaten to become prohibitive.
Investors concerned the euro zone debt crisis will get worse before it gets better have been piling into a diminishing number of safe havens, including bonds issued by Germany.
Two-year yields dipped below zero for the first time, falling to -0.001 percent, while 10-year yields set new lows of 1.147 percent, down 4 basis points on the day.
"There is nothing to resist these moves," a trader said. "A policy response might stop it but there is no sign of that."
By contrast, Spanish bond yields surged this week to close to their highest level since the launch of the euro, raising questions about the country's ability to fund itself over the longer term.
Bunds edged off their highs as market players booked profits before the weekend to avoid being exposed to losses should policymakers take unexpected steps to curtail the latest debt crisis flare-up.
However, the retreat was expected to be temporary.
"The Spanish bond market is caught up in a vicious dynamic with the lack of response to the current phase of the crisis undermining investor confidence," said Lena Komileva, chief economist at G+ Economics.
"What's different in this latest phase is that the pressures are coming from the domestic markets ...with the retail deposit flight."
The head of the European Central Bank stepped up pressure on Thursday for a joint guarantee on euro zone bank deposits, as data showed Spaniards were shifting money abroad at the fastest rate since records began
The European Commission's top economic official, Olli Rehn, warned that the single currency area could disintegrate without stronger crisis-fighting mechanisms and tough fiscal discipline.
GLOOMY BACKDROP
The economic backdrop offered little comfort with the euro zone's manufacturing sector contracting at its steepest in nearly three years in May, data showed.
Traders said many investors were also avoiding putting on large positions before US employment data later in the day. UK markets are closed on Monday and Tuesday for public holidays, which will have the knock-on effect of reducing trading volumes across Europe.
"US payrolls is the main event and the data yesterday was supportive but unless it is dramatically different to expectations it may not have too much of an impact given all that is going on in Europe," a trader said.
"The question is how are people going to set up ahead of the long weekend in the UK. I can't see why Bunds should sell off too far, there doesn't seem to be any sign of an imminent policy response."
Bund futures were last 28 ticks higher at 146.31, having set a new record of 146.63.
Spanish 10-year government bond yields were little changed at 6.597 percent, but holding below euro era highs of 6.80 percent for now.
Additional pressure is expected on Spanish bonds ahead of a debt auction next week. Traders said primary market dealers were expected to absorb the issuance but may find it harder to pass the paper on to end holders.
Spain is almost wholly dependent on its domestic banks to support bond auctions as international investors have steadily sold the paper this year.
A worse-than-expected US non-farm payrolls report, due at 1230 GMT, could spur Bunds higher after private payroll data released on Thursday showed the labour market recovery was stalling - one factor behind the rally in Bunds.
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