LONDON: Bunds extended falls on Tuesday as riskier assets continued their recent recovery on the view that euro zone policymakers were preparing decisive action to tackle the bloc's debt crisis, though the risk of a swift reversal remained high.
Bund futures dropped by over a full point to a session low of 135.95 -- the lowest since Sept. 16.
This came after large losses on Monday with officials now seen to be considering plans to boost the size of the euro zone's rescue fund to enable it to halt the spread of market pressure to Italy and Spain.
"If this was implemented it would be a great step towards the addressing of the situation, so this is positively read by markets," said Patrick Jacq, strategist at BNP Paribas.
The move into riskier assets was also supported by talk that the European Central Bank could extend its liquidity provision to include one-year loans and possibly re-enact its covered bond purchase programme.
European stocks rose sharply and Bunds remained under pressure despite Spanish minister Elena Salgado denying plans to extend the region's EFSF bailout fund to 2 trillion euros. The European Commission also said formal talks had not yet started on ways to enlarge the fund.
With no firm proposals on the table, and any significant changes to the European Financial Stability Facility subject to a lengthy approval process by member states, the appetite for safe-haven Bunds could return, market participants said.
"There seems to be a bit more noise on plans ahead, but whether they get it through or not is another matter... It's a classic post-big EU conference rally, but the question is 'has it got legs beyond two or three days?'," said a trader.
Technical analysis by PIA First showed momentum remained negative for Bunds, and a fresh buy signal would only emerge if the contract broke above 137.66 -- the peak of an intraday bounce seen on Monday.
The Sept. 1 intraday low of 135.69 offered the next technical support level, according to PIA First charts.
German 10-year bond yields rose 10.2 bps on the day to 1.93 percent, well above last week's record lows of around 1.64 percent.
"While we could see further limited sell-offs in the market ... below 2 percent on the 10-year Bund we know that the market is mainly driven by bid for safety," said BNP Paribas' Jacq.
PERIPHERALS PERFORM
In line with the strong performance by riskier assets, debt issued by Italy and Spain outperformed German Bunds, causing yield spreads to narrow for the fifth session running.
The Italian/German 10-year bond yield spread narrowed 16 bps on the day to 367 bps, from around 400 bps on Sept. 21. The equivalent Spanish spread was 316 bps, 19 bps tighter on the day.
The cost of insuring the countries' debt also fell according to CDS data provider Markit
Nevertheless, sales of short-term Italian debt came at a high price for the heavily indebted sovereign, with the cost of issuing a two-year zero-coupon bond at its highest since July 2008.
"I expect the main take away from these auctions to be that although risk sentiment has improved slightly over the past three sessions, peripheral funding pressures remain severe," said Peter Chatwell, strategist at Credit Agricole, in London.
Spain also had to pay an increasing price to persuade investors to buy up three- and six-month bills.
Greek lawmakers are expected to approve a fresh property tax at a vote set for around 1600 GMT as the country continues to press ahead with austerity measures aimed at securing the next tranche of bailout funding it needs to avoid a default in October.
Copyright Reuters, 2011
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