LONDON: Five-year German bond yields held near record lows on Wednesday ahead of an auction as investors weighed up appetite for safety against record low returns, with deep-seated concerns about Europe's political and economic landscape dominating sentiment.
That uncertainty combined with unease about Spain's debt-ridden commercial banking system drove that country's benchmark yields through the key 6 percent level.
The backdrop was fundamentally favourable for the issuance of safe-haven German debt, with worries over Greece's political future and membership of the euro, and questions about whether French president-elect Francois Hollande would act on his growth-friendly rhetoric.
But for some, a 5 billion euro auction of a new 5-year Bobl would be a hard sell given the meager returns on offer.
Five-year yields rose 1.6 basis points to 0.54 percent, as traders tried to cheapen prices to make way for the auction. They earlier touched a record low of 0.52 percent.
"I don't think it's going to be a big success because we are at a level where we don't see any buyers from the retail side. We only see traders trying to take five or ten ticks in the cash market" said Charles Berry, trader at Landesbank Baden-Wuerttemberg.
"My bid-cover ratio guess is something like 1.1, 1.2. I simply cannot imagine that people will run and rush into this auction."
The German Bund future was up 8 ticks at 142.63 near record highs of 142.66.
But some analysts said the myriad of uncertainty surrounding the future of Greece and the euro zone debt crisis would be enough to secure demand at the sale.
A failure by the two main pro-bailout parties to get a majority in government has left Greece in a political vacuum and also risks compromising its life-support bailout money, potentially threatening its membership of the euro.
"We will be in for another record low level also in the primary market... that leaves the bond for investing purposes on a total return basis rather unattractive," David Schnautz, strategist at Commerzbank said.
But he added: "We expect very decent demand even at these yield levels just against the backdrop of all that uncertainty all over the euro zone."
PERIPHERAL RISK
Radical leftist Alexis Tsipras meets the leaders of Greece's mainstream parties on Wednesday, with little chance of clinching a deal on a coalition government after he set tearing up an EU/IMF bailout deal as a condition.
Without bailout funds, Greece could default and restructure again, and analysts have said this increases the chance it may have to leave the single currency.
Greek 10-year bonds yielded 23.16 percent compared to 23.43 percent in late European trading on Tuesday. Morgan Stanley strategists recommended taking profits on the Greek curve in a research note.
"We take profits on our trade (buying GGB 2042s, selling GGB 2023s, hedged by long GDP warrant) that we recommended in late March in anticipation of further curve inversion," the bank's strategists said in a research note.
Peripheral debt also came under pressure. Ten-year Italian government bond yields rose 12 basis points to 5.75 percent,
The Spanish equivalent jumped 20 basis points to 6.06 percent. One trader said there were only offers for Spanish debt in the market, no bids.
"There are new concerns about the Spanish banks ... and the Greek election result is still having a bit of overhang in the market, so the flight to quality continues," a second trader said.
Spanish credit default swaps rose 19 basis points to 512 bps, according to provider Markit.
Financial sources said late on Tuesday the Spanish government would demand its banks raise around a further 35 billion euros ($45.5 billion) in provisions against soured loans in their property portfolios.
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