Spanish yields fall to near six-month lows on Fed outlook
* Fed starts two-day meeting on Tuesday
* Spanish, Italian yields fall on Fed stimulus outlook
* Fed outlook also supports Bunds
LONDON, Oct 29 (Reuters) - Spanish bond yields hit their lowest in nearly six months on Tuesday on investor expectations the Federal Reserve will keep its current level of monetary stimulus until early next year.
Italian government bond yields also fell and German Bund futures spiking to a two-month high as the Fed outlook supported bonds across the credit spectrum.
The Fed started a two-day policy meeting, its first since a 16-day U.S. government shutdown caused by political fighting over the budget earlier this month.
The shutdown is likely to have weighed on the U.S. recovery and traders expect the Fed to keep buying bonds at the current $85 billion a month pace until at least March.
Before the shutdown, investors had expected the Fed to start trimming the massive programme in December.
"The market is very positive, especially on the bigger peripheral countries Spain and Italy, because people believe liquidity will stay abundant with the Fed delaying tapering," said Alessandro Giansanti, a strategist at ING.
"We have seen support for Italian and Spanish bond issuance as well and this can go on until the end of the year because there's less concern on the credit risk of these countries... Spain is pursuing reforms, the economy is coming out of recession and political risk has lessened in Italy."
Spanish 10-year yields fell 4 basis points to 4.05 percent, the lowest since early May before the Fed hinted it might trim its monetary stimulus this year. Equivalent Italian yields fell 6 bps to 4.14 percent.
The deal that reopened the government only provided funds until mid-January, raising the risk of another budget standoff early in 2014, which could further hit growth.
"Given the political uncertainties, the impact of the shutdown, the fact that the economy was slowing even before the shutdown, they will have to send a dovish signal," said Elwin de Groot, senior market economist at Rabobank in Utrecht.
Many in the market also expect the European Central Bank to loosen monetary policy further to support a fragile recovery from a strong euro and curb a rise in money market rates from dwindling excess liquidity in the euro system as banks repay the ECB's long-term loans. The ECB holds a policy meeting next week but is not expected to move until next year.
Bund futures were up 12 ticks to settle at 141.27, off an earlier two-month high of 141.32. Cash 10-year German yields were 1 basis point lower at 1.74 percent.
Some traders said upcoming supply of triple-A rated debt was preventing Bunds from climbing further.
Finland sold 1.5 billion euros of 2018 and 2042 bonds. Germany will auction up to 4 billion euros of 10-year debt on Wednesday.