LONDON: Benchmark German government bonds hit new record price highs on Tuesday, knocking yields to their lowest ever as market nerves frayed over Greece's chances of keeping its euro membership after an election of mainly anti-austerity politicians. The rally was expected to slow down, however, given the price.
A five-year German debt auction could even put the brakes on on Wednesday if bidders show reluctance to buy the bonds at levels close to record lows yields.
While the defeat of Greece's pro-bailout parties in Sunday's election raised concerns over whether the country can keep vital international aid flowing and made investors risk averse, markets were not in a state of panic.
"We continue in a risk off mode, but a lot of the bad news is priced in," one trader said. "A lot of people have given up on Greece already ... and you've got to wonder - is Europe going to emerge stronger if Greece goes its own way?"
"Sure the markets are nervous and Bunds can go a little higher. But if (10-year) yields get to 1.40-1.45 we would be looking to sell."
Benchmark 10-year Bund yields hit a record low of 1.542 percent, 6 basis points lower in the day. Bund futures hit a record high of 142.55, continuing a multi-week rally that has taken them more than 700 ticks higher.
Piet Lammens, strategist at KBC said shorting the Bund was not a profitable trade right now but he was also not advising clients to buy the contract at current levels.
Also highlighting a general sense among investors that there was no reason yet to panic, Italian and Spanish benchmark yields were little changed, albeit at high levels close to 6 percent.
MOMENTS AND MILLIONS
The appetite for Bunds and the degree to which investors' are more concerned about the return of their money than making any gains on their bets will be tested on Wednesday, when Germany plans to sell up to 5 billion euros of five-year bonds.
Germany saw less bids than the amount on offer at two of its bond sales last month with bidders unhappy with the low level of yields. Each time the rally in secondary markets took a break.
"You tend to jump back 3 or 5 basis points after a bad auction and we can be in that situation again," Credit Agricole's global head of fixed income strategy David Keeble said.
"It's literally a case that every moment that we're rallying today is just taking away a few millions in bids at the German auction ... I don't think technically you're going to get this one covered."
Dutch and Austrian bond auctions on Tuesday benefited from the flight to safety on Tuesday, but they were smaller in size and had the advantage of a strong and disciplined bid from domestic investors like usual.
They were not necessarily taken as a sign that the German auction may go smoothly as well.
"It just emphasizes the point that spreads (premiums) relative to Bunds are that much more attractive and with Bund yields where they are and a lack of alternatives given uncertainties elsewhere, there is demand by default," said Marc Ostwald, strategist at Monument Securities.
Markets were also eager to see how far French President-elect Francois Hollande can change Europe's policy focus from austerity to restoring growth. The first meeting between Hollande and German Chancellor Angela Merkel, whose country has spearheaded Europe's austerity drive, would be closely watched.
"Up to then, everybody is going to talk about how growth can be combined with austerity, but we need something concrete until we get that it's going to be a push for lower (German) yields," said Achilleas Georgolopoulos, strategist at Lloyds.
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