Bunds rally on Greek woes, slowdown concerns

LONDON: German government bonds rallied on Thursday as weak euro zone and US data added to nagging uncertainty over whether Greece will get vital aid to cover its looming financing gap.

Benchmark Bund yields broke below 2.9 percent and Bund futures rallied more than a full point to 127.22 after business surveys signalled tepid growth in the euro zone's private sector and data showed more people became unemployed in the US last week than expected.

Meanwhile, Greece's new finance minister met with international lenders, with local newspapers reporting he was trying to amend proposed austerity measures that are key to securing more aid, further unnerving markets.

"I think the rally in Bunds will continue, mainly due to the risk of Greece, the slowdown in the economy, the continued decrease in commodity prices, which is affecting inflationary expectations," said Alessandro Giansanti, an ING strategist.

He said an outperformance of 30-year German bonds versus Bunds on Thursday, with the yield spread narrowing 4 bps to 72 bps, could be considered a sign of a shift in asset allocation by major investors from equities into fixed income.

Giansanti sees yields falling towards 2.7 percent in the current rally as uncertainty about Greece continues.

On the charts, the next big target is around 2.8 percent, which is the 23 percent retracement of the June 2007-December 2008 fall and also of the April 2010-August 2010 drop.

Nomura rate strategist Sean Maloney warned the slowdown could have also been caused by supply chain effects after the Japanese earthquake in March, weather-related effects in the United States and the Greek crisis.

"We ... suspect markets are being lured into a false sense of pessimism that could reverse quite sharply in the second half of the year. But do you fight it here and now? It's quite difficult to do."

'BROKEN PERIPHERY'

As European leaders pushed Greece to take harsh measures in exchange for funds and tried to coerced banks and insurance companies to maintain exposure to Greek sovereign debt when their bonds mature, Spanish spreads went out 19 bps to 279 bps.

Portuguese yields continued to hit fresh euro era highs on fears that a Greek restructuring would pave the way for Lisbon to make a similar move.

Greek five-year credit default swap prices were near record highs, up 163 bps at 2050 bps, with Portuguese CDS up 30 bps. Reuters calculations based on Markit prices show an 84 percent probability of default for Greece, based on a 40 percent recovery rate and a 51 percent probability for Portugal.

"Periphery markets are broken and their yields could go all the way," said Donal O'Mahony, global rate strategist at Davy's Stockbrokers.

Core CDS prices have come under renewed pressure, on fears over the cost to countries such as Germany and France if the euro zone debt crisis spreads.

German 5-year CDS prices have risen 10 bps this month to 45 bps but are still well below this year's highs of 60 bps hit in January. Similarly, French CDS have risen 20 bps to 86 bps, versus 2011 highs of 110 bps.

"Everything is being pulled in the same general direction because of fears of contagion should the Greek situation deteriorate further and it spreads right through the periphery," said Markit analyst Gavan Nolan.

"Clearly there will be an impact on the German and French financial systems if that happens, and if people want to go short it's often easier to do it through the CDS rather than the bond market."

Copyright Reuters, 2011