Volatility is set to remain high in coming weeks with Bunds and other safe-haven assets seen extending gains in the near-term as investors become increasingly pessimistic over global growth and turn edgy as the debt crisis threatens to engulf Italy and spread even further.
"The market is going through another stage of the crisis," said WestLB strategist Michael Leister.
"The willingness to put money at work seems to be limited because ... there is so much uncertainty on the debt crisis and also on what's going to happen with global growth. This volatility is going to continue for a couple of weeks."
Bund futures settled 34 ticks lower at 132.96, having gained some 800 ticks from lows seen on July 22 -- the day after euro zone policymakers agreed a second bailout for Greece, which also imposes losses on private bondholders.
Intra-day swings for Bunds reached 325 ticks this week, while analysts say the average daily range is about 50 ticks. Higher US Treasury prices on Friday also reflected the demand for safe-haven assets.
Rumours -- strongly denied -- about the stability of some French banks have increased volatility and regulators banned short-selling of some of their stocks from Friday. But although equities recovered some ground, the FTSEurofirst was still down over 100 points since the start of August.
"The measure does nothing in relieving investors' concern about the economic outlook, the debt problems and so on," said Kornelius Purps, rate strategist at UniCredit.
Analysts said previous short-selling bans had not supported stocks in the longer run.
The US temporarily banned short-selling in 799 banks and other financial institutions four days after the Lehman Brothers collapse in 2008. While share borrowing fell during the three-week ban, financial stocks continued to plummet.
HOPES AND DOUBTS
The focus switched to a meeting between French President Nicolas Sarkozy and German Chancellor Angela Merkel on Tuesday .
Analysts said the market appeared to be hoping for an enlargement of the euro zone bailout fund, the European Financial Stability Facility, or other types of fiscal transfers to tackle problems on the bloc's periphery, but doubted anything substantial would emerge from the meeting. "Expectations may be running a little high for further bold steps to tackle the crisis and which may not be delivered," said Commerzbank rate strategist David Schnautz.
"As you come closer to the idea that the meeting may not be a game changer, then basically you have to go a little more pro Bunds and a little more risk averse."
Hope before meetings of euro zone policymakers has been frustrated in the past, but demands for action have grown since the recent escalation in the crisis.
France became the target of market speculation this week, hit first by rumours of a credit rating downgrade then by talks of problems in its banking sector.
French 10-year yields dropped as much as 10 basis points to their lowest since Nov. 2010 at 2.95 percent and the French/German 10-year yield spread dropped 9 bps on the day to 66 bps, having hit a euro-era high of 91 bps last week.
"We've had some relief over the past few days given the (planned) meeting between Merkel and Sarkozy and as all three rating agencies confirmed the French ratings, and there is some profit taking going on," said WestLB's Leister.
"But (France's) vulnerability to swings in market sentiment looks quite high to us."
Leister and ING strategist Padhraic Garvey both recommended investors to be short France versus other euro zone triple-A rated countries such as Germany, the Netherlands or Austria.
Italian and Spanish 10-year yields were stable at just over 5 percent, having fallen more than 100 bps this week as the European Central Bank bought debt issued by the two countries.
Traders expect the ECB to keep buying their bonds, but say volumes may thin out in the next few days as the bank would be reluctant to bring yields below current levels and will try to keep politicians motivated to implement austerity measures.
Copyright Reuters, 2011