LONDON: Better than expected euro zone manufacturing data pushed Bunds lower on Tuesday, overshadowing another setback in negotiations on a Greek debt swap deal which is vital to avoid a chaotic euro zone default.
Finance ministers overnight rejected an offer made by private creditors to restructure Greek debt as insufficient, prolonging seven months of talks dangerously close to March, when Greece runs out of money.
But there remain other more positive signs in the euro zone's debt crisis. Yields for Italy and other borrowers have come down since banks were given nearly half-a-trillion euros of cheap loans in December, while the International Monetary Fund plans to boost its resources.
Despite Germany's denials, intensifying talk of an increase in the capacity of the euro zone's bailout mechanisms was also mitigating risk aversion, traders said.
"The fact that we are still yet to reach an agreement is still negative ... it is another example of the difficulties Europe has in reaching a timely resolution to its problems," said Brian Barry, fixed income analyst at Evolution Securities.
"But ... as regards to banking financing the potential for a credit crunch has been averted and ... there is a feeling that the path of getting resources needed to tackle the crisis is on the right track."
Bund futures were last 22 ticks lower on the day at 137.21, a fresh one-month low. Benchmark ten-year yields were 2 basis points higher at 2 percent.
Bunds reversed initial gains after PMI data showed Germany's manufacturing sector grew in January for the first time since September, easing fears of a looming euro zone recession.
POSITIVE FRAME OF MIND
Traders also said the broad market feeling was that the risk of a euro zone break-up if Greece defaults in a disorderly fashion would be a scenario scary enough for both parties to eventually reach a deal.
"There seems to be a fairly positive frame of mind," one trader said. "I'm sure the market is just going to believe they will go back in talks and come back with a new deal."
The technical picture could also be turning bearish for Bunds. Momentum indicators such as the MACD (moving average convergence divergence) have been falling over the past few sessions, and a settlement below the zero line would be seen as a "sell" signal.
"With the MACD still positive for now though, it's possible for a short term recovery to materialise, but this appears to be limited by the 38 percent Fibonacci retracement of the latest sell-off at 138.39, around which we will ... recommend a new short," UBS technical strategist Richard Adcock said.
If the selling signals are confirmed, the next target on the downside for Bunds would be the 62 percent retracement of the November to January sell-off at 135.85, Adcock said.
Italian 10-year yields were down 8 bps to 6.05 percent, having fallen nearly 150 bps in the past two weeks. The spread over German Bund yields narrowed to 407 bps.