Bunds resume sell-off after weak 5-year auction

LONDON: German government bonds resumed this week's sell-off on Wednesday after a poorly received 5-year bond auction and as Greece's lenders returned to the country to consider the disbursement of further aid.

Markets held onto hopes that the euro zone's bailout fund could be expanded, despite a lack of details on such a move, but even previously agreed measures did not seem set in stone with Germany suggesting the agreed Greek bailout plan may be renegotiated before it has even been ratified by member states.

The "troika" of international lenders to Greece will resume its mission to Athens on Thursday, a spokesman for the European Commission said, adding that finance ministers of euro zone states will hold an additional meeting in October to discuss Greek finances.

"We're faced with some very binary outcomes here," said Nomura rate strategist Sean Maloney.

"If they leverage the EFSF it would be a gamechanger but it would also take a very long time to get off the ground. So markets are very sensitive to headline risk around that and around Greece."

Talk of proposals to leverage up the soon-to-be 440 billion euro bailout fund have lifted global equities and weighed on bond markets.

Officials, including German finance minister Wolfgang Schaeuble, denied an increase in the volume of the European Financial Stability Facility bailout fund was planned.

But his French counterpart made clear there were tactical reasons to avoid discussing how to boost the fund before Germany ratifies previous amendments on Thursday.

"There's still lot of hurdles to overcome before any substantial improvement in risk appetite can be achieved," said Nick Stamenkovic, rate strategist at RIA Capital Markets.

"Even though the market is increasingly optimistic the EU is recognising the severity of the problem...they still don't seem any nearer to putting any sort of measures in place."

December Bund futures were down 40 ticks at 135.48, having risen as high as 136.29.

"The Bund has severed its two-month uptrend and 20 day moving average," said Commerzbank technical analyst Karen Jones. "While this is negative we are not yet convinced that the market has topped."

Jones said 135.50-135.12 was a key support area and a close below there would be needed to confirm the market had peaked. A break above 139.19 could open the way towards 139.40 and 140.00, she added.

Two-year German bond yields were 5 basis points higher at 0.593 percent, with 10-year yields up 3 basis points at 1.99 percent, having briefly popped above 2 percent for the first time in two weeks.

"The sort of volatility we're seeing is not unexpected and is likely to continue," said Nomura's Maloney.

"Risk-taking is off the table for a lot of accounts which is not a great environment for efficient market trading."

Finland votes later in the day on proposals to widen the scope of the EFSF, as agreed by the EU leaders on July 21, and Germany on Thursday.

GERMAN AUCTION SUFFERS FROM LACK OF DEMAND

The current reversal in appetite for low-risk assets was highlighted by a poorly received German 5-year bond sale, where the 1.25 percent coupon was the lowest on such paper since the euro was launched, according to Credit Agricole.

Despite offering a 10 basis point yield pick-up over the current benchmark, demand for the new bond fell short of the 6 billion euros on offer.

"Clearly, the recent recovery in risk-appetite is taking its toll here," said WestLB rate strategist Michael Leister.

"However, this does not come as a surprise, as 5-year yields below 1.25 percent were unlikely to attract substantial real money interest in the first place."

Italy also sold 750 million euros of index-linked bonds ahead of its 8 billion euro BTP sale on Thursday.

Copyright Reuters, 2011