German Yield Drops to 3-Week Low on Fed as French Bonds Rally

German bonds led European government securities higher after the U.S. Federal Reserve unexpectedly refrained from reducing the pace of its asset purchases, boosting demand for fixed-income securities.

Ten-year bund yields slid to a the lowest since August as stocks jumped after Chairman Ben S. Bernanke said the Fed must determine its policies based on the economy even if it surprises markets. French 10-year yields dropped to five-week low. Spanish bonds rallied for a fourth day as the nation’s borrowing costs fell at a 3.08 billion euros ($4.17 billion) debt sale. Portugal’s bonds underperformed all the region’s debt markets as Standard & Poor’s said it may cut the nation’s credit rating.

“The Fed was dovish,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG in Frankfurt. “Bunds will lead the rally initially, but with the Fed risk out of the way the outlook for spreads is improving.”

German 10-year yields declined seven basis points, or 0.07 percentage point, to 1.93 percent at 4:30 p.m. London time after reaching 1.85 percent, the lowest since Aug. 30. The 2 percent bund maturing in August 2023 rose 0.655, or 6.55 euros per 1,000-euro face amount, to 100.65.

The MSCI All-Country World Index of stocks climbed 1 percent, while the Stoxx Europe 600 Index rallied 0.5 percent.

The Fed yesterday maintained its monthly purchases of $85 billion of bonds and mortgage-backed debt, saying it needs more evidence of an improvement in the U.S. economy. Analysts had forecast policy makers would cut Treasury purchases by $5 billion to $40 billion.

Yields Slide

The rate on French 10-year bonds dropped nine basis points to 2.42 percent, after reaching 2.34 percent, the lowest since Aug. 15. The yield on similar-maturity Dutch securities slid seven basis points to 2.29 percent. Belgian 10-year yields declined eight basis points to 2.71 percent.

“We expect a lot of volatility in the coming months until the Fed clearly communicates how it will reduce the bond buying,” said Christian Reicherter, an analyst at DZ Bank AG in Frankfurt. “We don’t think it will be a sustained move down in yields. In a few days the discussion will be begin about if the Fed will start tapering in December.”

Volatility on German bonds was the highest in euro-area markets today, followed by those of Belgium and Finland, according to measures of 10-year debt, the yield spread between two- and 10-year securities, and credit-default swaps.

France sold 3.05 billion euros of five-year notes at an average yield of 1.23 percent, compared with 1.09 percent at a previous auction on July 18. It also sold 2.53 billion euros of two-year securities at 0.39 percent and 1.92 billion euros of 2016 debt to yield 0.43 percent.

Spanish Auctions

Spain’s borrowing costs dropped as it allotted 2.06 billion euros of three-year notes at an average yield of 2.225 percent, compared with 2.636 percent at a previous sale on Aug. 1. The Madrid-based Treasury also sold 1.02 billion euros of 15-year bonds at 4.809 percent.

The Spanish auctions resulted in a “positive set of results as exemplified by the notable decline yield relative to previous sales,” Richard McGuire, senior fixed-income strategist at Rabobank International in London, wrote in a note to clients. “Given the shot in the arm for risk appetite in the form of the Fed’s surprising decision to stand pat yesterday, these positive results were perhaps to be expected.”

Spanish 10-year yields fell eight basis points to 4.32 percent, while the rate on similar-maturity Italian bonds declined 11 basis points to 4.29 percent.

The extra yield, or spread, investors demand to hold Spain’s 10-year bonds instead of German bunds widened five basis points to 245 basis points after dropping to 235, the narrowest since July 1, 2011.

Portugal’s BB long-term credit rating may be cut if the government fails to meet its budget deficit goals and implement reforms, S&P said yesterday. It raised the risk of a downgrade on the country by putting it on “creditwatch” with a negative outlook. The nation’s 10-year bond yield fell two basis points to 7.16 percent.

German securities lost 2.7 percent this year through yesterday, according to Bloomberg World Bond Indexes. Italy’s returned 3.8 percent and Spain’s earned 8.6 percent.

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