Bunds fall, downside limited by contagion concerns

LONDON: German bonds fell on Tuesday as investors cashed in on the previous day's rally but signs that the euro zone crisis was spreading beyond the weaker euro zone states should provide the market with some underlying support.

There has been no shortage of negative news to hit the region in the past week: euro zone officials cannot agree on the need for a Greek bailout; rating agencies say most forms of restructuring would constitute default; and the outlooks of both Belgium and Italy were cut to negative.

While market players were taking profits on a surge in Bund prices on Monday to five-month highs, broader economic uncertainty is likely to limit the downside of any bond move.

‘There is an immediate concern about Greece's situation and obviously the credit ratings agencies have pretty much reinforced the concerns about contagion, now that they put Italy and Belgium on negative outlook,’ said Orlando Green, European fixed income strategist at Credit Agricole CIB.

‘These are all things that are playing into the hands of those that are bullish on the core market,’ he added, referring to those who have bets on bonds rising.

The June Bund future fell 22 ticks to 124.96 on Tuesday, also weighed down by a better-than-expected German Ifo business sentiment survey.

The closely watched Munich-based Ifo think tank said German business sentiment was unchanged in May, confounding expectations for a third decline in a row.

The 10-year German Bund yield

was 2.9 basis points higher at 3.048 percent, having tested the psychologically key 3 percent level in the previous session.

A break beyond that key level could open the way for a rise towards the 126 ticks area in the Bund future, Commerzbank strategists said in a research note.

SPREAD-STRESS SPREADING

The spread between peripheral bonds and German Bunds tightened slightly after widening sharply the previous session when fears over the euro zone debt crisis hit the assets of heavily indebted countries.

The Greek/German 10-year yield spread was down 12 basis points on the day at 1,416 basis points and the equivalent spread between Spain and Germany narrowed to 247 basis points as Spain easily sold 2.3 billion euros of short-term debt.

But bonds of heavily indebted countries were expected to remain under pressure as the latest ratings moves heightened the perceived risk of contagion of the euro zone debt crisis to other states in the region.

Fitch's downgrade of Belgium's outlook to negative ‘yet again seems to indicate that the debt crisis is spreading further and further out,’ Michael Leister, strategist at WestLB said.

In a similar vein, Moody's said on Tuesday a Greek debt default would hurt other peripheral euro zone states, making it the last of the three major rating agencies to warn Athens over the implications of any restructuring.

The fear is that credit ratings agencies could eventually downgrade the ratings of bigger euro zone economies -- which would heighten fears over the fall-out of the euro zone debt crisis and shake financial markets.

‘There is plenty more to come from the rating agencies. The danger is we get one of the big boys,’ said a London trader, referring to France.

The cost of insuring Greek debt against default rose 27 basis points on the day to 1,440, according to data monitor Markit, with markets unconvinced about the government's latest fiscal plans.

The Greek government, which enjoys a comfortable majority in parliament, launched a long-stalled privatisation programme and announced other deficit-reduction measures on Monday, but the leader of Greece's conservative opposition rejected the new package, saying it would not help the economy to recover.

Copyright Reuters, 2011