LONDON: Investors clamoured for euro zone government bonds when markets opened for 2016 on Monday with tensions in the Middle East and a sell-off in Chinese stocks driving demand for safe-haven debt.
Yields on most 10-year bonds were 5-6 basis points lower across the region, and short-dated German government yields fell to their lowest in about two weeks.
European and U.S. stocks tumbled more than 2 percent with Chinese shares slumping 7 percent after data showed Chinese factory activity contracted for a 10th straight month in December.
Heightened tensions between Iran and Saudi Arabia encouraged investors to seek safety in bond markets.
Saudi Arabia, the world's biggest oil exporter, cut diplomatic ties with Iran on Sunday in response to the storming of its embassy in Tehran. Tensions between the two escalated after Riyadh's execution of a top Shia cleric at the weekend.
"Flight to quality is the name of the game today which is proving very favourable for bonds and very bad for stocks," said Jean-Francois Robin, head of strategy at Natixis.
A resumption of the European Central Bank's bond-buying programme on Monday after a temporary pause for the Christmas break was also seen supporting euro zone bonds.
The yield on two-year German bonds dipped to a two-week low of -0.359 percent. German five-year bond yields also fell to a two-week low at -0.085 percent while 10-year yields fell 6.3 bps to 0.57 percent.
U.S. Treasury yields were also sharply lower, with 10-year yields down 6 bps at 2.21 percent, after data showed U.S. construction spending fell for the first time in nearly 1-1/2 years in November.
Despite the risk aversion, analysts said traders were not expecting the Federal Reserve to have to slow the pace of its rate increases. They said short-dated Treasury yields would have fallen more if traders were taking that view.
Back in Europe, ultra-low consumer price growth continued to present a headache for the ECB, adding to the downward pressure on yields.
German inflation unexpectedly slowed in December and the rate for the whole of 2015 fell to its lowest level on record, data on Monday showed. Euro-wide data is due on Tuesday.
Yet some analysts still remain confident that an upsurge is just around the corner.
"In the coming months we expect to see a boost to annual inflation rates - as the steep declines in oil prices between October 2014 and January 2015 continue to fall out of year-on-year calculations," said UBS in a note to clients.
Elsewhere, bonds from Catalonia showed little reaction to the prospect of new elections in the Spanish region after a far-left party on Sunday voted against supporting nationalist regional President Artur Mas for re-election.
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