German yields hold near highs, U.S. debt deal still expected


By Ana Nicolaci da Costa

LONDON, Oct 14 (Reuters) - German bond yields held nearthree-week highs on Monday as markets stayed confident theUnited States would resolve its fiscal stalemate despite asetback over the weekend.

Bipartisan talks to bring the crisis to an end broke down onSaturday in the House of Representatives and shifted to Senateleaders. Senate talks showed signs of progress on Sunday, butthere were no guarantees the shutdown would end or that ahistoric debt default would be avoided.

The U.S. government has been partially shut since Oct. 1 andfaces an Oct. 17 deadline to raise its borrowing limit or becast into what the head of the International Monetary Fund hassaid would be "massive disruption".

Trade was expected to be thin with U.S. Treasury marketsclosed for Columbus Day.

"We had this setback over the weekend but we know that goinginto the end of the week ... the market remains convinced ...there will be an agreement," Patrick Jacq, European ratestrategist at BNP Paribas, said.

Ten-year German yields were little changed onthe day at 1.86 percent - not far from a near three-week high of1.89 percent hit on Friday. German Bund futures were 7ticks lower at 139.72.

Jacq expected German yields to trade around 1.85 percentthis week and said the U.S. impasse would provide an excuse forinvestors to cash in on recent gains made on the euro zoneperiphery after solid bond sales last week.

"I think there will be time for some profit-taking andclearly the situation in the U.S. could offer some pretext forthat to happen," Jacq added.

Ten-year Italian bond yields were up 1 basispoint at 4.30 percent and the Spanish equivalent were flat at 4.31 percent.

Italy's borrowing costs were sharply lower at a sale of upto 6 billion euros of bonds on Friday, rounding off a week ofhefty debt sales in Rome and Madrid which drew robust interest.

The solid auctions highlighted the improved sentimenttowards the euro zone's debt-ridden southern economies, which islikely to support a Spanish sale this Thursday.

But one trader said the scope for a sell-off in lower-rateddebt was also limited given the confidence on a last-minute U.S.debt deal.

"Peripheries traded quite well last week given the amount ofsupply so I think we expect that to continue for now," he said.

"We think periphery will continue to grind tighter over theweek. We have a little bit of Spanish supply to contend with butwe think it will be fairly small in size."

Spain will sell three- and five-year bonds on Thursday.


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