Spanish and Italian yields fell on Tuesday as a bailout deal for Greece insulated lower-rated euro zone bonds from a flight to safe havens triggered by China's devaluation of its yuan currency.
Greece and its international lenders clinched a deal expected to be worth about 86 billion euros and to save Athens from default on a debt repayment of 3.2 billion due to the European Central Bank on Aug. 20.
Greek 10-year yields fell half a point to 10.66 percent, while two-year yields dropped more than three percentage points to just below 16 percent.
In a global flight towards top-rated assets, which pushed yields on benchmark Bund yields and U.S. Treasuries 4-5 basis points lower and weakened stock markets in Europe and Asia, the Greek deal meant peripheral bonds held strong.
The yuan devaluation raised concerns about the extent of the economic slowdown in the world's second biggest economy and its knock-on impact on other regions.
"The Chinese devaluation was taken as 'things are not going that well in China' and this is a risk-off move," said Martin van Vliet, senior rate strategist at ING, adding that "with the Greek deal secured and the ECB continuously buying bonds, peripheral spreads would have been much tighter otherwise."
Spanish and Italian 10-year yields fell 4 basis points each to 1.94 percent and 1.80 percent respectively and the difference between them and German yields tightened slightly to 112-128 bps.
Another factor driving yields lower in the euro zone was the expectation that a slowing Chinese economy may dampen inflation prospects in the euro zone, pushing the European Central Bank to provide more stimulus.
The ECB's preferred measure of the market's long term inflation expectations, the five-year, five-year breakeven forward traded around its lowest in two months just above 1.7 percent.
The yuan move, aimed at boosting the economy, in fact exacerbated concerns about it.
"It's a reflection of how concerned Chinese authorities are about the economy, which is slowing faster than expected," said Nick Stamenkovic, bond strategist at RIA Capital Markets.