Bunds fall on Fed hopes but market cautious

LONDON : German government bonds fell on Thursday, retreating further from record highs on hopes US Federal Reserve Chai

Traders have been speculating on whether Bernanke will use his appearance at a central banker conference in Jackson Hole, Wyoming, on Friday to signal a fresh round of monetary stimulus to help a weakening US economy.

While the speculation has helped equity markets rally this week, but many doubt the Fed chief will immediately commit to a third round of quantitative easing, making some in markets wary of a reversal of recent moves.

"The hurdles to another round of quantitative easing are quite high," said Nick Stamenkovic, rate strategist at RIA Capital Markets.

"So while Bernanke will be cautious about the current outlook and may reiterate possible policy initiatives they could announce in future, he is unlikely to unveil anything new tomorrow, hence there could be disappointment."

September Bund futures were last at 134.12, down 42 ticks from Wednesday's settlement close. The contract has shed more than 2 points from its record highs hit last week but is still around its previous highs set in late 2010.

"Bernanke has already pledged low interest rates for two years and he has to stay dovish but it will probably be a bit of a wash-out and that does mean that pullbacks prior to the speech will be shallow," said a trader.

Two-year German bond yields were 3.5 basis points higher at 0.758 percent, with 10-year yields up 5 basis points at 2.23 percent.

Italy and Spain return to bond markets next week with the first auctions since the European Central Bank began to buy the two countries' bonds and this may support Bunds.

Italy will sell new 10-year bonds with a 5.0 percent coupon as well as 3-year bonds and floating-rate notes on Tuesday, while Spain sells five-year bonds on Thursday.

Italian 10-year yields have crept back above 5 percent despite the ECB stepping up its purchases of the paper.

"They've ramped up the buying just to keep BTPs at 5 percent so they've really got a lot of work to do to get this auction to go well," one trader said.

"But it's very binary. If it goes well, people will say it's down to the ECB and if it goes badly then you will see a negative reaction. The risks are all to the downside."

Greek two-year bond yields were 65 basis points higher at 44.77 percent after rising more than 400 basis points on Wednesday as an escalating row over demands by Finland for collateral on Greek loans was seen complicating implementation of a second rescue package.

"Greece is missing, in the first seven months of the year, its deficit reduction targets as the recession reduces the tax receipts for the government," said ING rate strategist Alessandro Giansanti.

"In this environment, the odds of a full default event for the Greek bonds have substantially increased."

Greece agreed last week to provide cash collateral for triple-A rated Finland's loans in a bilateral deal that sparked requests for similar treatment from Austria, the Netherlands and Slovakia. This prompted rating agency Moody's to warn that Greece's bailout payments could be delayed.

 

Copyright Reuters, 2011

 

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