European Bonds Fall on Praet Comments Amid Fed Taper Speculation

European government bonds fell, led by Spain and Italy, after European Central Bank policy maker Peter Praet said the region’s banks may reduce purchases of sovereign debt to lower their risk profile.

Spanish five-year yields climbed the most in five weeks after falling to the lowest level since 2005 yesterday as investors weighed the prospects of the Federal Reserve cutting asset purchases as soon as this month. Italy’s 10-year bonds snapped a four-day advance, while German two-year yields climbed to the highest level in three months. Investors have boosted holdings of the region’s higher-yielding bonds versus those of core nations in the past two weeks, JPMorgan Chase Bank said.

“The market is driven by a combination of speculation over the timing of the Fed tapering and over potential new capital requirements to back sovereign-bond holdings,” said Martin Munksgaard, a fixed-income salesman at Danske Bank A/S in Copenhagen. “People in the market are digesting what it will mean if sovereigns are no longer treated as risk free.”

Spain’s five-year yield rose seven basis points, or 0.07 percentage point, to 2.66 percent at 4:22 p.m. London time, the biggest increase since Nov. 5. The 3.75 percent note maturing in October 2018 fell 0.34, or 3.40 euros per 1,000-euro ($1,375) face amount, to 104.91.

The nation’s 10-year yield climbed six basis points to 4.09 percent after dropping to 3.995 percent yesterday, the lowest since Nov. 4.

Praet, in an interview with the Financial Times published today, said if a planned review of the region’s banks known as the Comprehensive Assessment puts pressure on them in a way that forced them to cut lending, the ECB may act by providing additional liquidity.

Banks ‘Wary’

“Treating banks’ holdings of sovereign debt according to the risk that they pose to banks’ capital makes it unlikely that the banks will use central bank liquidity to excessively increase their exposure to sovereign debt,” he said in a transcript released by the ECB. “This is because banks will be wary of the constraints placed on sovereign debt by the stress tests to which they are subject at the same time.”

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

German Yields

German two-year yields rose two basis points to 0.25 percent after touching 0.26 percent, matching the highest since Sept. 11. The 10-year rate increased three basis points to 1.84 percent.

Treasury 10-year yields jumped five basis points yesterday amid speculation a U.S. budget agreement reached this week will make it easier for the Fed to reduce its $85 billion a month in asset purchases.

U.S. policy makers will begin paring stimulus at their Dec. 17-18 meeting, according to 34 percent of economists surveyed on Dec. 6 by Bloomberg, an increase from 17 percent on Nov. 8.

European government bonds are “following the move in Treasuries,” said Michael Markovich, head of global interest-rate research at Credit Suisse Group AG in Zurich. “The likelihood of tapering has increased.”

Italian 10-year yields rose four basis points to 4.10 percent. The extra yield over similar-maturity German bunds widened one basis point to 2.25 percentage points after shrinking to 2.21 percentage points on Dec. 11, the narrowest since July 2011.

Slovenian Bonds

Slovenia’s 10-year yields dropped 20 basis points to 5.40 percent, set for the lowest close since January, as a European Union official said the country won’t need external aid to repair its banking system.

“When the Commission concluded eight months ago that the Slovenian economy was suffering from excessive imbalances, I stated that the situation was still manageable provided swift and decisive policy action was taken,” EU Economic and Monetary Affairs Commissioner Olli Rehn said in a statement. “While significant challenges remain, I’m pleased to say that this has so far been the case.”

Investors significantly increased their “long exposure” to peripheral bonds versus those of core countries in the past two weeks to the highest since at least 2010, Aditya Chordia, a strategist at JPMorgan Chase Bank in London, wrote in a note today, citing a client survey.

Spanish bonds returned 12 percent this year through yesterday, the third-best performer of 15 euro-area debt markets tracked by Bloomberg World Bond Indexes. Italian securities rose 7.7 percent, while Germany bonds fell 1.6 percent.

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