Investors sought refuge in short-term German debt on Wednesday as Greece and its creditors met in a fresh attempt to stave off a messy default, while ample European Central Bank cash helped a Portuguese bill sale.
Nearly half trillion euros in three-year ECB loans to banks have eased sales of short-dated euro zone debt in recent weeks but the year's biggest test so far comes on Thursday when Spain seeks to sell bonds with maturities up to 10 years.
Germany saw the strongest demand for its two-year paper in more than six months, even though it offered rock-bottom returns. At 0.17 percent, the average yield was similar to that paid by France on three-month debt earlier this week, underscoring Germany's status as the euro zone's top-rated borrower.
Portuguese bills were snapped up despite Standard & Poor's downgrading the country to junk last week. Yields mostly fell, though at more than 4 percent for maturities measured in months, they highlighted the gulf in perceived credit quality.
France, which lost its top-notch rating on Friday sells medium-term paper on Thursday and may benefit from the ECB cash but the real test will be Spain, especially with investors jittery over the Greek debt talks.
The returns on the (Spanish) BONOs look good relative to Bunds but the euro zone crisis is a long way from being resolved, Marc Ostwald, strategist at Monument Securities said.
Against that backdrop, Germany sold 3.44 billion euros of bonds, drawing bids worth more than twice the amount on offer.
With Germany left unscathed as the only triple-A rated euro zone country with a stable outlook after last week's mass S&P rating downgrade, demand was higher than even a month ago.
It is confirming that there is an interest in the safety of the German bonds no matter what the level of yield is, Alessandro Giansanti, rate strategist at ING said.
The fact that there is a lot of uncertainty first of all on what is going on with the debt exchange in Greece is fuelling safety bids.
Talks broke down last week over the interest rate Greece will offer on new bonds and a plan to enforce investor losses, though there was rising optimism a deal could be reached.
The market showed little reaction to the bond sales.
SNAPPING UP JUNK
At the other end of the credit spectrum, Portugal's 2.5 billion euro sale of treasury bills saw demand from domestic banks feeling flush with ECB liquidity.
Domestic banks are behind it, obviously. They can present a small (amount) of the bills as collateral with the ECB to raise money, Achilleas Georgolopoulos, rate strategist at Lloyds said.
The average yield on 11-month bills, which accounted for half the sale, was a shade under 5 percent. Portugal last issued 11-month paper in April, just before it sought a 78-billion-euro bailout. Then yields hit a record 5.9 percent.
It's the first time they try to raise money with one-year bills since the bailout and the first auction after the downgrades to junk so it's more a positive rather than a negative result, Georgolopoulos added.
(Additional Reporting by Annika Breidthardt and Madeline Chambers, editing by Nigel Stephenson)