Greek debt woes keep Bund yields below 3pc

LONDON: German ten-year Bund yields hovered below 3 percent on Monday and the paper was seen supported in the near term by uncertainty over whether Greece will receive a vital new tranche of bailout funds.

EU and IMF officials are expected to give their verdict on Greece's faltering drive to bring its deficit under control later this week, and payment of the lenders' next aid tranche was far from certain, with the government failing to get opposition backing for fresh austerity steps.

If Greece fails to get funds, it faces the possibility of default over the summer. Euro zone leaders' indecision over what should be the solution to the crisis was also hitting sentiment, with markets increasingly pricing in some form of restructuring.

Benchmark Bund yields were last up 0.8 basis points at 2.993 percent, while Bund futures were 6 ticks lower at 125.58, having opened higher at 125.68. UK and U.S markets were closed for national holidays.

"We have headline risk out of Greece and it could go either way, but on balance risk is off as the situation is unclear," said Rainer Guntermann, strategist at Commerzbank.

"We have a neutral tactical recommendation for today. (Ten-year) yields could stay just below 3 percent for a little longer, they could even fall further if the risk-off (sentiment) were to see another boost."

"Once the Greek situation is resolved and once the next ECB rate hike takes shape," Bund yields would rise back above 3 percent, he said.

The next target for Bund yields is seen at 2.95 percent, which is the 38 percent retracement of the August 2010 to April 2011 rise, and the following is at 2.90, a Dec. 6, 2010 high.

The main concern should Greece restructures its debt is that other lower-rated euro zone states would suffer from contagion and possibly face similar consequences.

For now, sentiment towards stronger peripheral countries held firm and an Italian auction saw good demand despite the bank holiday in the UK. Ten-year Italian/German yield spreads were 4 bps wider at 181 bps.

"It's a reassuring result given what's happening in Greece," ING strategist Alessandro Giansanti says.

SEEKING CONSENSUS

With the European Central Bank strongly opposing debt restructuring, some European politicians against unconditional aid and the Greek opposition against proposed budget moves, consensus on Greece was looking like a distant prospect.

On Monday, Greece's opposition leader said there was no scope for consensus if the government raised taxes, while ECB board member Lorenzo Bini Smaghi said the notion of an orderly restructuring was a "fairytale".

KBC strategist Piet Lammens said it was unlikely that the IMF's assessment on Greece would be favourable as the country probably missed its programme targets, and investors would be kept on their toes until the next step becomes clear.

"You cannot be sure about how things will pan out. The IMF cannot come out with this report unless there's a plan B ... Will this be possible within a week? I have my doubts," he said.

The next key development, he said, is when one of the sides involved in negotiating a solution shows signs of a softer stance. If it comes from the ECB that may mean that a restructuring is in the pipeline, while if it comes from European countries, it may mean a new bailout could be agreed.

Either way, Greek yields were likely to remain at elevated levels as markets were increasingly convinced debt haircuts could be imposed at some point.

At around 1,450 bps, Greece's 5-year credit default swaps indicate a 73 percent probability of a default based on a 43 percent recovery rate, according to Reuters calculations from Markit data.

"Probably politicians will find a solution, but even if they are successful this time, nothing can be a game-changer," one trader said.

The Greek/German ten-year bond yield spread was last 23 basis points higher on the day at 1,390 bps. Two-year yields were up 50 bps at 26.14 percent.

Copyright Reuters, 2011