LONDON: Benchmark German bond yields were on course on Tuesday for their biggest daily fall since mid-July, though they held within touching distance of recent highs on expectations the Federal Reserve would soon start slowing bond purchases.
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.
Bets on Fed tapering and better data in the euro zone saw German yields post their biggest weekly rise since June last week.
They fell on Tuesday as Bund futures rebounded but analysts said a sustained rally would only be fuelled by weak economic releases and, with a thin data calendar, that was 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 Bund yields were 3.8 basis points lower at 1.86 percent having risen as far as 1.924 percent on Monday - their 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. 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 - their highest since July 2011. They were last down 6.4 basis points at 2.82 percent.
The greater risk for the market was for the Fed minutes to be more dovish than expected, analysts said.
"With everything priced (in), if we get any sort of slight hint that ...expectations for September might be a little bit premature, then we can see a further recovery kicking in here in core bond markets," Philip Tyson, strategist at ICAP, said.
SHRINKING PERIPHERAL PREMIUMS
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 3 basis points wider on the day at 256 bps and the Italian equivalent was 3 bps wider at 242 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."
Tyson also said peripheral spreads had limited scope to narrow further from current levels given that the underlying issues in those countries persisted. He said spreads could come under renewed pressure, once the German elections passed.
"There is not enough growth to eke into the unemployment levels or the crippling levels of debt they are burdened with," he said, adding the political situation in places like Italy and Portugal remained fragile.
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