Bunds Drop as Fed Stimulus, German Court Ruling Damp Safety Bid

German 10-year government bonds dropped for a second week, with the yield climbing to the most since April, after the Federal Reserve announced a third round of asset purchases to stimulate the U.S. economy.

The declines pushed two-year note yields to the highest level in more than two months as investors reduced holdings of the safest assets. Italian bonds led gains among the so-called euro-area periphery nations, rising relative to bunds, as Germany’s Constitutional Court cleared the way for the setup of Europe’s permanent bailout fund. The yield on German 10-year bunds yesterday climbed the most since Aug. 3 as euro-area finance ministers met in Cyprus.

“The strength of relief is very large,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. “There’s probably more room for the periphery to perform because people are desperate for yield.”

Germany’s 10-year yield rose 19 basis points, or 0.19 percentage point in the week, to 1.71 percent at 5 p.m. London time, after being as high as 1.72 percent, the most since April 30. The 1.5 percent bund due in September 2022 fell 1.695, or 16.95 euros per 1,000-euro ($1,314) face amount to 98.13.

The nation’s two-year yield climbed to 0.106 percent yesterday, matching the most since July 3.

Italian Spread

The additional yield, or spread, that investors demand to hold Italian 10-year bonds instead of bunds fell to 331 basis points yesterday, after being as low as 326 basis points, the least since April 2. Spanish 10-year bonds yielded 410 basis points more than bunds, after the spread slipped below 400 basis points this week for the first time since April.

The U.S. central bank announced on Sept. 13 its third round of asset purchases since 2008, giving investors the confidence to buy higher-yielding assets. Stimulus will be expanded until officials see “sustained improvement” in the labor market, Fed Chairman Ben S. Bernanke said.

German bunds also dropped as the nation’s top constitutional court cleared Europe’s permanent bailout fund for ratification, damping demand for the safest government debt.

Germany must make sure its share of the 500 billion-euro European Stability Mechanism is capped at 190 billion euros, the court said in its ruling on Sept. 12.

European Central Bank President Mario Draghi said yesterday that there’s reason for optimism in Europe.

Draghi Comments

“Financial conditions have been better recently, but we have to continue working on that,” Draghi said after a meeting of euro-area finance ministers in Nicosia. “If we continue going this way, one has to be optimistic.”

Declines by bunds may be limited next week amid speculation a report will show services and manufacturing industries in Europe contracted in September.

A composite index of both industries was at 46.6 this month, from 46.4 in August, London-based Markit Economics will say on Sept. 20, according to the median of 23 economists surveyed by Bloomberg. A reading below 50 signals contraction.

German bonds returned 2.5 percent this year through Sept. 13, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Spanish securities advanced 1.7 percent, while Italy’s debt made 15 percent.

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net

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