LONDON: German government bonds edged lower on Wednesday with markets optimistic that despite further delays in talks Greece will agree to the reforms necessary to secure aid and avoid a messy debt default.
But Bunds bounced off their worst levels with the key 2 percent yield level holding while an early rally by the euro zone's higher yielding issuers faded after Spain launched a syndicated tap of its 10-year bond.
A solid 3.3 billion euro 5-year German auction also helped contain the losses in safe-haven paper although with the bonds relatively expensive compared with other maturities on the yield curve, demand was not as strong as at a January auction.
"Not as strong a result as at the last sale but certainly adequate when viewed against the backdrop of the ongoing lack of yield advantage at the "true core" and the current glass-half-full risk-on market move in anticipation of a Greek deal," said Rabobank rate strategist Richard McGuire.
A deal on private sector debt holders taking a loss on their bond holdings and politicians agreeing austerity measures is likely to lead to a further sell-off in Bunds and support paper issued by the more indebted euro zone countries.
"We slowly seem to be crawling towards an agreement and if those two things are passed we could see a further unwinding of the safe-haven bid," said Nick Stamenkovic, rate strategist at RIA Capital Markets.
However, even if a deal is reached, Greece still has to deliver on reforms and the wider euro zone crisis remains unresolved.
A lack of growth in Portugal makes it unlikely it will regain access to capital markets next year while Italy relies on European Central Bank liquidity to support its debt sales.
"There's still going to be lots of ifs and buts but for now you can see how sensitive the market is to any news on Greece," Stamenkovic added.
Greek parties resume talks on Wednesday, seeking a deal in return for a new international bailout after a series of delays which have prompted some EU leaders to warn that the euro zone can live without Athens.
The Wall Street Journal reported that the European Central Bank has made concessions over its holdings of Greek bonds. The ECB had been considering finding a legal way to give up the profits it would have made on the debt to Athens.
Spanish 10-year bonds underperformed their euro zone peers with 10-year yields 17 basis points higher at 5.27 percent after the launch of a syndicated tap of the January 2022 bond. Spain is aiming to raise 2 to 3 billion euros from the isuance.
The deal puts more bonds in circulation and it took the shine off an early rally for debt issued by the euro zone's struggling periphery. Italian 10-year yields failed to break below 5.50 percent and the spread over German Bunds - which hit its lowest since October at 350 basis points in early trade - was last eight basis points wider than that.
March Bund futures were 17 ticks lower at 137.78.
"It doesn't seem like people are massively long of Bunds so that might be supportive on the way down," a trader said.
Ten-year German yields were 2 bps higher at 1.98 percent, have briefly broken above 2.0 percent to test the top of the trading range seen since the start of the year.
"The two percent level is key but there's going to be an unwillingness to push that ahead of the European Central Bank meeting tomorrow, especially with all the Greek headlines," a second trader said.