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Lingering bailout concerns reverse Portuguese bond rally

Marius Zaharia
Wednesday, 4 Dec 2013 | 7:15 AM ET

* Portuguese bonds reverse some of their rally after debt swap

* Bunds fall after better than expected services PMI

* Demand falls at German five-year debt auction

LONDON, Dec 4 (Reuters) - Portugal's bonds weakened on Wednesday, reversing a rally fuelled by a move to lower its near-term debt refinancing burden, as concerns lingered that Lisbon may still need more international support.

The country swapped 6.6 billion euros of short-term bonds for longer-dated ones on Tuesday, a larger than expected amount that moves it closer to its goal of regaining market access next year as it exits a 78 billion euro bailout programme.

But Portugal still has to repay 5 billion euros of bonds maturing in June and 6.2 billion euros in October. Some analysts are wary that the country may need at least a precautionary credit line if not more cash from international lenders to finance those debt expiries.

"Standing completely on their own is going to be very difficult," said Peter Shaffrik, head of European rates strategy at RBC Capital Markets.

Portuguese 10-year yields rose 5 basis points to 5.95 percent, while two-year yields rose 9 bps to 3.42 percent. Yields fell by as much as 20 bps on Tuesday following the debt exchange.

"The debt swap was a good step forward, but ... still our view is that Portugal will require an additional helping hand," said Christian Lenk, strategist at DZ Bank.

Lenk said Portugal still faced political uncertainty next year as the ruling parties may have different views about the route the country should take after its bailout ends.

Other analysts highlighted the risk that the Constitutional Court will shoot down salary and pension cuts included in the 2014 budget to meet the demands of its creditors.

Some in the market, however, said Wednesday's market moves were just a pause in a longer-term bond rally and that the positive investor sentiment towards the country which has just started to grow again can gather momentum in coming months.

"They are following what Ireland did, that's the way we see it," one trader said. "They are slightly behind the pace but they're certainly moving in the right direction."

Ireland has not requested any additional aid following its bailout programme, which ends this year.

WEAK GERMAN AUCTION

German Bunds fell as data showed the pace of recovery in the euro zone private sector slowing but ahead of market expectations.

Investors are very sensitive to economic data before a European Central Bank policy meeting on Thursday, with many in the market expecting ECB President Mario Draghi to signal further monetary easing next year.

U.S. ADP national employment figures will draw special attention before Friday's non-farm payrolls report, which will be scoured for clues to whether the Federal Reserve will trim its bond-buying stimulus in December or next year.

Bund futures fell 26 ticks to 141.02, while 10-year Bund yields rose 2.4 bps to 1.755 percent.

An auction of 3.285 billion euros of five-year German debt drew significantly lower demand than a previous sale, with investors bidding for 1.6 times the amount sold versus 2.3 times last month.

"A somewhat soft set of results which is possibly not too surprising given the sizeable imminent event/data risk," Rabobank senior rate strategist Richard McGuire said.

"While the ECB is arguably more likely to prove supportive of, rather than provide a challenge to, front-end core yields ... non-farm payrolls the following day is much harder to read."