German bond yields fall as EU optimism falters

LONDON: Prices of 10-year German government bonds rose for the first time in five sessions on Thursday, as uncertainty over whether European officials would deliver on hopes for more bold, decisive EU action caught up with markets.

After four days of net losses, it was a choppy session with Bund futures falling in and out of negative territory as the unusual burst of optimism in recent sessions seemed to fade.

The euro's safest-bet bonds had sold off on speculation officials could be considering a further boost to the euro zone rescue fund that would benefit riskier issuers like Spain, Italy and others. But many analysts say such hopes are overdone and benchmark 10-year German bond yields have struggled to stay above 2 percent as a result.

Yields fell on Thursday even as German Chancellor Angela Merkel won a vote on enhancing the euro zone's bailout fund without needing to rely on the opposition.

"I think the market right now is quite confused ... It's very difficult to get a handle of what is right and what is not," John Davies, fixed income strategist at WestLB said of the recent bout of speculation and headlines.

"For now that explains why the 2-percent type area is still holding in place relatively well."

Ten-year German government bond yields rose as far as 2.009 percent earlier in the session but last stood at 1.95 percent compared to around 1.97 percent at the settlement close a day earlier.

The economic backdrop meanwhile remained overwhelmingly favorable for bonds.

Even if officials eventually confirm they are indeed considering a further boost the fund, investors are disheartened by the snail's pace at which changes are being implemented.

National parliaments are still voting on an agreement made in July to boost the funds and the power of the EFSF.

Greece also still has to secure more funding to avoid an imminent default -- Greek CDS prices put a 94 percent probability on it defaulting at some stage. International auditors return to Athens on Thursday to deliver a verdict on whether the government has done enough to secure more funds.

"I think it's overly optimistic to think that the whole crisis is over and therefore the safe-haven status of the Bund is lost. I wouldn't expect to see the Bund yield much higher than where we are in the short term," Elisabeth Afseth, fixed income analyst at Evolution Securities said.

The German Bund future jumped 25 ticks on the day to 135.91 -- still a way away from last week's record high at 139.19. One trader said the Bund had tested a key support level in the previous session at 135.12.

Copyright Reuters, 2011