EURO GOVT-Bund yields test key levels, seen rising longer-term

* Bunds test key technical levels, yields could move higher

* Portuguese yields rise again after another downgrade

By Marius Zaharia and Kirsten Donovan

LONDON, April 4 (Reuters) – German Bunds were little changed
on Monday as they tackled technical levels, but yields looks set
to resume a longer-term rising trend whether the ECB maintains a
hawkish tone on inflation after its meeting this week or is
deemed too dovish.

The ECB is widely expected to raise interest rates by 25
basis points on Thursday for the first time since October 2008
and markets price in about 100 basis points worth of hikes over
the next 12 months from the current record low of 1.0 percent.

Societe Generale economist James Nixon says markets will be
looking to see whether the ECB still believes the risks to
inflation are on the upside. Either way, ten-year bund yields
are set to rise.

“On a 12-month basis, if the ECB hikes rates by 100 basis
points we should probably see the Bund (yield) add another 30
basis points to about 3.7 percent,” Nixon said.

“If the ECB disappoints and they don’t do as much as that,
you would be looking at a Bund yield that should probably
approach 4 percent or above as the market becomes more concerned
that inflation is not adequately tackled.”

He also said he expects the two-year Schatz yield to rise by
80-100 bps over the next 12 months based on the 1 percentage
points worth of hikes scenario.

June Bund futures (FGBLc1: Quote, Profile, Research) were 11 ticks higher at 121.10.
Two-year bond yields (DE2YT=TWEB: Quote, Profile, Research) were less than 1 bps lower
at 1.818 percent, with 10-year yields (DE10YT=TWEB: Quote, Profile, Research) down 1 bps
to 3.370 percent.

Ten-year yields hit their highest level since the beginning
of 2010 on Friday — above 3.4 percent, breaking out of the
prevailing range of the last two months earlier in the week and
with closing levels marking new highs over the last 7 sessions.

Yields are now testing technical resistance marked by the 50
percent retracement of the fall in yields between 2008 and 2010.

“Yields should continue shifting upwards towards 3.5 percent
which is a round number closely watched by clients,” said WestLB
rate strategist Michael Leister.

“But short-term it’s not unlikely we could see a setback,
especially after the ECB, depending on the wording they use.”

Traders said volumes were low and there was a reluctance to
put on positions ahead of Thursday’s ECB meeting wherever yields
went before then.

FIVE-YEAR UNDERPERFORMANCE

Five-year bonds have underperformed 2- and 10-year paper
over the last two weeks as highlighted by the barbell measure
which shows how the 5-year yield moves relative to 2- and
10-year paper.

Using swap rates to avoid distortions in the underlying
market, the measure has risen around 2 bps to around 10 bps.

“Historically the five-year sector performs poorly at the
beginning of a rate hike period,” said Peter Schaffrik, rate
strategist at RBC Capital Markets.

“If you get another 3 to 4 basis points higher from here,
then that’s probably going to be close to the peak.”

During the last rate hike cycle, the measure reached its
highest between the central bank’s second and third rate rises.

There was little respite for the euro zone’s most indebted
issuers with Portuguese bond yields rising further after Fitch
cut the country’s ratings three notches to BBB- late on Friday
and signalled further downgrades are likely. [ID:nLDE73021D]

Portuguese yields marked new highs, a daily occurrence
recently, with 10-year yields (PT10YT=TWEB: Quote, Profile, Research) above 8.87 percent.

Although Lisbon managed to raise 1.6 billion euros through a
bond sale on Friday — which analysts believe should be enough
to meet April coupon and redemption payments — the country is
still widely expected to have to ask for financial aid.

A spokesman for the Portuguese opposition social democrats
said the party would support a short-term loan but had not said
it backs a bailout as reported in some media [ID:nLDE7330NO].

Meanwhile, traders said Spanish Prime Minister Jose Luis
Rodriguez Zapatero’s decision not to seek a third term in 2012
elections would raise questions over Madrid’s future commitment
to economic reforms.

Spanish bonds were unfazed on Monday however, with the
10-year yield spread over Bunds narrowing 4 bps to 190 bps and
the market for time being drawing a line in the sand of the euro
zone debt crisis after Portugal.
(Reporting by Marius Zaharia; Editing by Ruth Pitchford)

EURO GOVT-Bund yields test key levels, seen rising longer-term