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German Bonds Fall on Flexible Yuan; Spanish Securities Advance

German government bonds fell, pushing the yield on the benchmark 10-year security to a one-month high, as stocks rose after China said it will allow a more flexible yuan, curbing demand for the safest assets.

The bund yield extended last week’s gain, the biggest this year, as the MSCI World Index of equities rose 1.1 percent and the 10-year U.S. Treasury yield gained five basis points. Spanish bonds rose for a third day, narrowing the extra yield investors demand to hold them rather than German securities, as concern nations may struggle to pay their debt subsided. The European Central Bank slowed purchases of sovereign debt to the least since its bond-buying program started on May 10.

“The news from China underpinned the bearish tone for bunds with Treasuries, although it’s difficult to tell what the longer-term effect may be,” said Marcel Bross, an interest-rate strategist at Commerzbank AG in Frankfurt. “Spain was performing very healthily on Friday and we’re still playing this tightening pattern.”

Germany’s 10-year bond yield increased four basis points to 2.78 percent as of 4:42 p.m. in London, after reaching 2.78 percent, the highest since May 20. The 3 percent security maturing in July 2020 fell 0.40, or 4 euros per 1,000-euro ($1,239) face amount, to 101.92.

The Spanish 10-year bond yield fell 11 basis points to 4.52 percent, narrowing the yield difference with bunds 17 basis points to 174 basis points.

Yield Trough

The yuan rose the most since a July 2005 revaluation today after the People’s Bank of China said on June 19 it will allow greater currency “flexibility.” Yesterday, it ruled out “large changes” in the exchange rate and said it will prevent “excessive” moves.

Bund yields fell as low as 2.50 percent this month amid concern Europe’s debt crisis may deepen and cause global growth to falter. Strong demand at debt auctions last week for so-called periphery nations including Spain renewed confidence in the countries’ ability to fund their budget deficits, weakening demand for German debt.

This week the Netherlands, Portugal and Italy plan to sell government bonds. Dutch 10-year securities slipped, with the yield three basis points higher at 3 percent. Equivalent-maturity Portuguese yields fell one basis point to 5.71 percent and Italian 10-year yields were little changed at 4 percent.

“The better risk appetite on the back of the announcement from China to make the yuan more flexible should support euro-zone spreads,” Wilson Chin, a fixed-income strategist at ING Groep NV in Amsterdam, said today in an e-mailed report. “Having said that, the effect is likely to be small and short-lived given the euro-zone debt crisis is likely to linger for the coming months.”

Greek Austerity

The ECB started buying government bonds last month to support a rescue plan for nations facing rising debt costs that was forged by the European Union and worth almost $1 trillion. Purchases of government bonds slowed to 4 billion euros last week, down from 6.5 billion euros the week before. The bank has bought a total 51 billion euros of securities, it said today.

ECB Executive Board member Juergen Stark said today the central bank’s government bond-purchase program is of a “temporary nature” to help restore investor confidence in the region.

“It’s by construction a temporary measure in order to calm down markets,” Stark said at an event in London today. “Markets have calmed down. I’d like to stress the temporary nature of this program.”

Executive Board member Jose Manuel Gonzalez-Paramo said governments in the euro area need to address the root causes of high bond spreads. The risk premium on Spanish debt over German bonds “doesn’t have much to do with” what would be “reasonable” levels, he told reporters in Bilbao, Spain, today.

‘Clear Risk/Reward’

The bond buying may cause bunds to underperform U.S. Treasuries, according to Royal Bank of Scotland Group Plc.

“Markets’ fears about who funds the ECB and what the ECB owns (lots of potentially defaulting instruments, and growing) implies a clear risk/reward,” Andrew Roberts, head of European rates strategy in London, said in a June 18 investor report. “U.S. Treasuries will outperform bunds.”

The European Commission, the EU executive in Brussels, said in a report issued today that it may be “some time” before the EU labor market shows an upswing.

“The economy started to recover from deep recession around a year ago, but it may take some time yet before the fragile pick-up in economic activity and confidence triggers an upswing in the labor market,” it said.

Government bond price declines should be seen as an opportunity to buy the securities because market jitters over a potential weakening of economic growth will support demand, Nomura Holdings Inc. said today.

“We expect sensitivity to be high to any further signs of slowing, and at the very least, this is likely to cause extra volatility,” a team of Nomura analysts led by Nick Firoozye in London said in an investor report. “This means that bonds will remain in favor. Dips are ultimately still buying opportunities.”

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