Bunds rise, outperform Treasuries on US debt worries

LONDON: German government bonds rose on Monday, outperforming US Treasuries, as fears of a default by the world's largest economy overshadowed debt worries in the euro zone.

US Treasury yields rose and European shares opened lower as the debt impasse in Washington stirred more worries that political wrangling between lawmakers will prompt a cut in the United States' AAA credit rating.

Although analysts still expect a last-minute deal to raise the US debt ceiling and avoid a default next week, it seems unlikely that Democrats and Republicans will agree before the election in November 2012 on how to find $4 trillion through government spending cuts and revenue increases. .

"Something will probably be sorted out but the real problem is that longer-term they need to get their fiscal house in order and the deficit under control or they could be downgraded," said Lyn Graham-Taylor, rate strategist at Rabobank.

September Bund futures were 11 ticks higher at 127.80, having retraced losses seen since details of policymakers' plans for a second Greek bailout were leaked on Thursday.

Ten-year German cash yields were 2 basis points lower at 2.808 percent.

"Bunds should outperform Treasuries, the clock is ticking and it's starting to look a bit close," a trader said.

US 10-year yields were 1.5 bps higher at 2.979 percent, pushing the spread over 10-year Bunds 3 basis points wider to 17 basis points. But analysts said the euro zone debt crisis was a bigger worry for the medium term.

"The likelihood of a technical default by the US Treasury in early August is rising rapidly and such an occurrence would be traumatic for markets, but we suspect it could hit risk assets harder than Treasuries," Lloyds Bank strategists said.

"Implementation risks and political disagreements in the euro area are still the biggest medium-term risk. While a US downgrade or a technical default would probably not constitute a 'Lehman moment', the demise of the euro would."

Yields on bonds issued by Italy and Spain remained at elevated levels on doubts over whether steps taken last week to ring-fence the euro zone debt crisis went far enough.

Spanish 10-year yields were 5 basis points higher at 5.85 percent, with Italian yields up 7 basis points at 5.485 percent.

Italy, in particular, is likely to stay under pressure with around 10 billion euros of supply expected this week.

"The new (euro zone rescue) framework may appease market fears for now, but one must not forget that amongst the fanfare, we are witnessing the first Western developed country default in over half a century," said Dave Chappell, senior fund manager at Threadneedle Investments, which manages $107 billion in investments.

"A more robust growth profile than is currently expected is now key for the prospects of calm returning to the financial markets."

Chappell said the fund began to reduce its "sizeable underweight" position in Spain and Italy last week, but buying only the most liquid on the run issues.

Euro zone officials and bankers plan to conduct a voluntary swap of privately held Greek bonds for longer maturities within a few weeks to minimise the period during which Greece is in partial default, a senior EU official said.

Moody's downgraded Greece's sovereign debt ratings by three notches to Ca and said the country still faced serious medium-term solvency challenges but the move had little impact.

Belgium will sell up to 2.5 billion euros of 2017, 2021 and 2041 bonds.

Copyright Reuters, 2011