Bunds rise as shelter sought ahead of bank tests

Yields rose on debt issued by lower-rated euro zone countries, with Italy and Spain bearing the brunt of pressure as short-term uncertainty added to longer-term concerns that the region's debt crisis is spreading to larger economies.

The safe-haven bid pushed German Bund futures up by half a point, also supported by credit concerns over US debt after a fresh warning that Treasuries could lose their triple-A status.

Analysts said results due later on Friday of a health check on Europe's banking sector, aimed at reassuring investors, were unlikely to ease market tension and cause Bunds to give up their recent hefty gains.

"If we were to see a significantly positive surprise we might see some investor books in some profits, but we don't see there's any chance that this can be sustained," said Michael Leister, strategist at WestLB in London.

A low number of failures were likely to call the stringency of the tests into question and a high number would fan the flames of concerns over policymakers' lack of decisive action to tackle the spreading sovereign debt crisis, analysts said.

Bund futures were last 31 ticks higher on the day at 128.73

However, traded volumes in the contract were below average as investors were reluctant to open new positions ahead of the stress test results at 1600 GMT, after the day's settlement close.

"I'd be neutral going into (the results) but until there's a solution to the bigger picture problems that people see as tangible and could work, Bunds are the only place to be," said Alan McQuaid, chief economist at Bloxham Stockbrokers.

Policymakers are struggling to find a way to shape a fresh bailout deal for Greece that causes private sector losses without triggering wider systemic problems.

Those fears, along with domestic concerns, have put Italian debt in the spotlight, and despite a successful bond auction on Thursday and the likely smooth passage of fresh austerity measures, the country's bonds remained under pressure.

The lower house of Italy's parliament is expected to give final approval to an austerity plan worth 48 billion euros at around 1600 GMT.

Nevertheless, the Italian/German 10-year government bond yield spread widened by 6 bps to 297 bps, dragging the equivalent Spanish spread wider by a similar margin to 320 bps.

BUNDS OUTPERFORM T-NOTES

Triple-A German bonds outperformed 10-year Treasuries after a second rating agency this week warned the US could lose its prized triple-A rating.

Standard and Poor's put the world's largest economy on negative watch, stating there was a one-in-two chance it could cut the United States' Aaa rating if the government debt limit was not lifted.

Moody's placed the US on review for downgrade on Wednesday.

The gap between Bunds, which carry a lower yield, and 10-year T-notes widened for the second session in a row, out by around 7 bps to 24 bps.

"The 20-25 basis points are the middle of the range here and we really need to break 30 on the upside or down into single digits again before the volume on that trade comes back," a trader said.

10-year German yields were 2.4 basis points down at 2.719 percent, with two-year debt at 1.23 percent, down 2.7 bps on the day.

Copyright Reuters, 2011