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Robust U.S., euro zone data hurts euro zone bonds

Emelia Sithole-Matarise
Wednesday, 4 Dec 2013 | 12:58 PM ET

* German 10-year yields hit 6-week high

* French debt risk premium at 6-month low

* Portuguese bond rally falters

LONDON, Dec 4 (Reuters) - Euro zone bonds fell across the board on Wednesday as U.S. data showed growing momentum in the world's biggest economy that could prompt the Federal Reserve to start scaling back its monetary stimulus soon.

German 10-year yields rose to their highest in six weeks, with the euro zone's safe-haven debt underperforming the rest of the market, notably French bonds, whose 10-year yield premium hit its lowest in six months at around 40 basis points.

Bunds were on the back foot early in the session after data showed the pace of recovery in the euro zone private sector slowing but ahead of market expectations.

The sell-off gained pace after stronger-than-expected U.S. employment figures - a precursor for non-farm payrolls data on Friday - that suggested the labour market is robust enough for the Federal Reserve to start trimming its bond purchases.

Investors are very sensitive to economic data before a European Central Bank policy meeting on Thursday and the Fed's next policy meeting on Dec. 17-18.

"The ADP employment data was strong and people are saying it could lead to payrolls on Friday being robust as well and increases the chances of Fed tapering," said Alan McQuaid, chief economist at Merrion Stockbrokers.

"The market is a bit nervous going into the big events of the ECB and the NFP (non-farm payrolls report), so going into that the bias for yields is going to be on the upside."

Bund futures dropped 90 ticks to end at 140.38, pushing the cash German 10-year yields 9 basis points to 1.82 percent, the highest since Oct. 22.

Dutch yields and Finnish yields were up by a similar amount, while Italian equivalents were 7 bps higher at 4.16 percent .

FRENCH SWEET SPOT

French bonds slightly outperformed the bloc's other higher-rated paper, pinching their yield gap over German Bunds by 4 bps to 40 bps, its least since May 20.

The risk premium on French bonds has been grinding lower over the past month as investors shrugged off a one-notch Standard & Poor's one-notch downgrade of the country's credit ratings. S&P warned the pace of reforms was not enough to put the euro zone's second largest economy back on track.

Although market participants have expressed concern at France's slow pace of reform, and that it could struggle to push through further unpopular changes, its ability to fund itself is solid and investors continue to like its liquid bond market.

"This is a country where access to capital markets is unquestioned, especially in an environment where the ECB has spoken out its willingness to help out sovereign members," said Kommer van Trigt, head of rates team at asset manager Robeco.

"What you see in the market is day-by-day, spreads are very stable for France, and also the interest of, for example, Asian investors remains very high ... If you look at our portfolios we are not overly cautious on French government bonds."

At the lower end of the credit spectrum, a rally in Portuguese bonds triggered by a move to lower the country's near-term refinancing burden stalled, caught up in the broader market sell-off. There were also some lingering concerns that Lisbon may need more international aid.

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.