UPDATE 2-Surprise German SPD leadership choice kicks bond yields to near 3-week high

Germany's borrowing costs rose on Monday after the Social Democrats (SPD) chose new leaders critical of their own ruling coalition, with yields on benchmark 10-year debt set for the biggest one-day spike in nearly three months. The election on Saturday of leftist Norbert Walter-Borjans and Saskia Esken raises the chances of an early election or minority government if the SPD leaves the government.

That could trigger instability at a time when the far-right Alternative for Germany (AfD) is the third-largest party or lead to increased spending by the German state if the coalition terms are renegotiated. "In Germany we've had the speech (from Esken) where she wants a higher budget deficit, and second it's clear that the coalition is coming to an end, so there is a political risk premium building in the bond markets," said Francois Savary, CIO of Swiss wealth manager Prime Partners.

Benchmark German bond yields jumped across the board, with 10-year yields up more than 7 basis points to -0.273%, their highest in nearly three weeks. Monday's rise was the biggest since mid-September. The German curve steepened, with yields on 10- to 30-year debt up around 4 bps from a week ago.

"Whatever actually happens from here, this news will likely get markets excited about an easier path to more German fiscal policy in the future," Deutsche Bank strategists said in a note. The rise in yields rippled over to the broader European bond market. Italian 10-year yields rose almost 10 bps to 1.436% , while Spanish and Portuguese yields jumped to their highest since July.

Analysts said the spike in Italian yields was due to investors de-risking their portfolios in the final month of the year and the high sensitivity of peripheral bonds to moves in core European debt such as German and French debt. CHINA SURPRISE

An upbeat China Caixin/Markit Manufacturing Purchasing Managers' Index (PMI) added to upward pressure on government bond yields. It rose to 51.8 in November from 51.7 in the previous month, the fastest expansion since December 2016. "We had some fundamentally good data on China over the weekend that is raising hopes that we have seen the bottom of the economy for now," DZ Bank rates strategist Rene Albrecht said.

The Chinese data fuelled some unwinding of long U.S. Treasury debt positions, with 10-year yields rising nearly 8 bps to 1.86%, a nearly three-week high. U.S. yields have been on a downward trajectory for most of November as hope for a U.S-China trade deal fade.

Irish bonds bucked the trend, with yields dipping after the sovereign regained a double-A debt rating it lost during the financial crisis. Investors are wary about the outlook for government debt in 2020, when net supply is expected to rise significantly, putting upward pressure on yields. JP Morgan estimates about $460 billion of new supply next year compared with demand for debt of about $400 billion seen in 2019.