Bunds down, but may recover as US debt talks drag on

LONDON: German Bunds fell on Tuesday, retreating from key technical levels, but are expected to remain well bid in the near-term due to investors' cautiousness during talks on lifting the US debt ceiling and debt crisis contagion fears in the euro zone.

Traders said markets remained in a risk-averse mood due to a deadlock in Washington on talks to lift the US debt ceiling before an Aug. 2 deadline to avoid a technical default and a potential cut in the country's AAA ratings.

However, investors were not panicking and many analysts expect a last-minute deal to be reached.

"Treasuries didn't really sell off yesterday so there's no real panic in the market yet. The market thinks in the end an agreement will be found," said Alessandro Giansanti, rate strategist at ING. "(But) there is still a flight to quality trade going on."

The Bund future was last 22 ticks lower at 128.04, retreating after failing to breach resistance at 128.46 -- the 62 percent retracement of last week's selloff -- in the previous session.

UBS technical strategist Richard Adcock said no reversal patterns were forming on the charts and he recommended buying the Bund. He said the next resistance would be met at 129.25, the level of the unfilled bearish gap from the July 19 settlement, followed by 129.70, levels around July 18 highs.

"At the moment we are in a buy-on-dips mode in Bunds," one trader also said.

The September futures contract briefly hit a session low of 127.76 after European Central Bank policymaker Christian Noyer said the bank was in a state of strong vigilance on inflationary pressures.

The move was faint as analysts and traders don't see an interest rate rise at next week's meeting.

"It would be very unusual to hike two meetings in a row," said Credit Agricole strategist Peter Chatwell.

"I think we have to assume that this is a reminder of the ECB's position, rather than a higher-level signal of an imminent hike. I would not be surprised to hear the position clarified, with 'closely monitoring' being the signal I would expect."

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The cost to insure fringe euro zone debt fell and Italian and Spanish bond yield spreads over Bunds eased about 10 basis points, but traders warned this move could be temporary, with 10 billion euros worth of Italian bonds supply looming.

At 5.57 percent, Italian 10-year yields are back around levels seen before details of a second rescue package for Greece leaked on Thursday, reversing falls made in the wake of the news.

Investors in lower-rated euro zone states remain edgy, as focus has turned on implementation risks for the European Union's latest anti-crisis measures.

The increased powers of the EFSF bailout fund need to be ratified by national parliaments and anyway markets believe they should be accompanied by heightened borrowing capacity to help insulate larger economies like Spain and Italy from the crisis.

Copyright Reuters, 2011