LONDON: German government bond yields were little changed on Wednesday as market players braced for a two-year debt sale some analysts said might struggle given the ultra-low yields on offer.
Investors will have to weigh appetite for safe-haven assets stemming from uncertainty over the euro zone debt crisis and Spain's fiscal position against the increasingly low returns offered by German paper. Al l -time low yields dampened appetite for a new 10-year bond sold last week.
The March 2014 Schatz to be auctioned on Wednesday last yielded 0.15 percent in the secondary market, near record lows touched last week and little changed on the day.
"I think it will be a similar kind of story (to the 10-year) because rates are still very low. When rates are low, there isn't an awful lot of value in the bond," said Padhraic Garvey, head of investment grade strategy at ING.
"But it will be taken down because rates are where they are for a reason, and that is that there is underlying demand for German paper."
Ten-year German government bond yields were steady at 1.67 percent. The German Bund future was up three ticks on the day at 139.99, having earlier hit a session high of 140.29.
Traders said failure to break below a key technical level had triggered some buying.
"After support held down at the 139.80 level, there were a couple of small stops triggered around 140.10-12 and in thin volume that's pushed us higher," said one of the traders.
SPANISH TEST
Good demand at a Spanish bill auction on Tuesday offered some respite for peripheral debt in secondary markets but a rise in short-term borrowing costs underscored the challenges still facing the highly indebted country.
Spain will auction up to 2.5 billion euros of 2014 and 2022 bonds on Thursday, while France is also due to sell debt.
"I think the market is very nervous ahead of it, a lot of people are trying to see it as a bit of a defining moment for Spain," a second trader said.
"I think the auction is small enough that it should go reasonably well. I don't think it's in the interest of the issuer, nor the potential investors to see it go badly."
Indeed analysts said a good auction would not be a make-or-break for sentiment towards the highly indebted country, but a bad one could quickly make matters much worse.
"The problems are there and none of these longer-term issues are being resolved, therefore one bill or bond auction which is a success, that solves the problem until we get to the next one," Marc Ostwald, strategist at Monument Securities.
"If it was a poor auction tomorrow, we'll be well through six heading for 6.25 (percent) I would imagine in 10-year (yield) terms."
Spanish bonds were higher on the day, with yields down 6.1 basis points at 5.85 percent. Italian bonds underperformed, with yields down 4 bps at 5.44 percent.
A draft document due to be approved by the cabinet of Prime Minister Mario Monti on Wednesday showed Italy would delay by a year its plan to balance the budget in 2013 due to a weakening economic outlook.
The document, which has been obtained by Reuters, raises the budget deficit forecasts for 2012-2014 and slashes this year's economic growth outlook.
Rabobank did not expect Italy's budget revisions to unsettle markets in the same way Spain's budget target revision did, jolting the county onto the frontline of the crisis.
"Even in the wake of these revisions, Italy's budgetary shortfalls remain modest," it said in a note.
"More importantly, the fiscal pressures in Spain are the product of less identifiable forces - specifically, uncertainty over the government's ability to control its wayward regions and ongoing concern over the scale of potential additional bailouts for the country's banking sector."
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