LONDON: German Bund futures rose on Wednesday as an agreement to boost the capacity of the euro zone rescue fund failed to quell nerves over its debt crisis, while the European Central Bank intervened to cap a surge in Italian bond yields.
A cut by agency Standard & Poor's in the ratings of a number of European and US banks added to worries over the health of the banking sector and prompted investors to dump financial shares in favour or safer government bonds.
Meanwhile, euro zone ministers agreed detailed plans to leverage the European Financial Stability Mechanism (EFSF) on Tuesday, but could not say by how much because of rapidly worsening market conditions, prompting them to look to the IMF.
Uncertainty remained over whether the EFSF would be able to attract private sector interest and on how the potential involvement of the IMF would be carried out.
"There were few surprises as far as the details about the EFSF leveraging are concerned (and there was an)official confirmation that the leveraging idea might run into practical limitations... and that investor appetite is not yet ensured," Rainer Guntermann, strategist at Commerzbank said.
"It's still a bit unclear how this coordination with the IMF will look like, whether it will work."
German Bund futures jumped 29 ticks to 133.68, with technical charts pointing to further potential upside.
"We expect the 132.05 Fibonacci retracement, or even the 132.89/94 support area ... to force the Bund to head north again," Societe Generale said in a note.
A close above the medium-term rising pullback line at 134.82 would be needed to confirm that the Bund is on its way back to the recent high of 139.58, it added. Yields on Italian and Spanish debt rose back towards unsustainable levels, with the 10-year Italian yield rising as far as 7.44 percent before coming back to trade up 4.7 basis points at 7.34 percent.
The 2-year yield rose 1.8 basis points to 7.23 percent, having risen as far as 7.59 percent earlier, with dealers saying the European Central Bank had bought small amounts of short-dated bonds for small amounts to ease the pressure.
Spanish 10-year government bond yields rose 5.8 basis points to 6.5 percent.
"It must also be remembered that the EFSF is already funding at very wide levels over Germany, struggled in its last auction to raise the required funds and would have its rating put under severe pressure by any rating downgrade of France," Rabobank strategists said in a note.
"This must call into question any plans relating to the EFSF -- it is yesterday's solution and the market has simply moved on."
Against this backdrop, the pressure remains on the European Central Bank to buy bonds more aggressively and on politicians to agree on steps towards a fiscal integration.
Berlin and Paris aim to outline proposals for closer fiscal integration before an EU summit on Dec. 9 that is increasingly seen by investors as a last chance to avert a breakdown of the single currency area.
"You need a significant break in this pattern of ever increasing yields, sometimes tempered by promises and solutions put forward by politicians which never quite get there," Gary Jenkins, head of fixed income research at Evolution Securities said.
"I think that the ultimate (response) would be a proper move towards fiscal union with common European bond issuance and at the same time while that's being done the ECB scrapping its temporary and limited support and actually invoking more of a QE (quantitative easing) approach."
He said large institutions were more concerned now with capital preservation than actual trading, and that German Bunds, UK gilts and US Treasuries were still the safest bets but all of them were now subject to risks.