UPDATE 2-French bond yields at over two-year low as "yellow vest" effect wanes

France's 10-year government bond yield dropped to its lowest since November, 2016 on Tuesday as the effect of the "yellow vest" protests faded. Other high-grade euro zone bonds were unchanged on the day, though Southern European bond yields dropped sharply on storming demand for Spain's ongoing 15-year syndicated bond deal.

A survey showed that French consumer confidence jumped in February to its highest since the protests began, as unemployment fears receded, reinforcing last week's strong purchasing managers' index. In addition, support for the "yellow vest" movement is waning, and French President Emmanuel Macron's popularity has recovered to levels not seen since the protests broke out in mid-November, a poll showed this week.

"What markets are starting to realise is that Macron seems to be quite stable in his saddle now and the 'yellow vest' effect is starting to fade," said DZ Bank rates strategist Christian Lenk. "The move (in French yields) is also in line with the idea that investors are looking for a pick-up with Bund yields so low, and the French curve at the long end in particular seems to be quite attractive."

Most euro zone yields fell on Tuesday, but French bonds outperformed, with 10-year yields dropping to 0.506 pct , down nearly 2 bps on the day and the lowest in 27 months. Last week, France sold 7 billion euros of 30-year bonds, getting orders for more than five times that amount.

"There seems to be some stabilisation: the phase where activity deteriorates might be over, giving hopes to the market the effect of the protests might fade," Mizuho strategist Antoine Bouvet said. "But we should remember these are sentiment indicators, which tend to recover quickly, not hard data. So I would be a little cautious."

German 10-year yields, the benchmark for the region, were hovering around the 0.10 percent mark, unchanged on the day. Federal Reserve chair Jerome Powell will testify to the U.S. Senate later in the day and markets will look for signs interest rate increases will resume later this year and the policymakers will stop running down the central bank's balance sheet.

SPAIN FLIES Elsewhere, Southern European bonds rallied as Spain generated storming demand for a 15-year bond sale, with order books exceeding 43 billion euros by mid-morning, according to International Financing Review.

Spain's outstanding 10-year bond yield dropped to a 28-month low of 1.13 percent, down three basis points on the day, while Italian and Portuguese equivalents were lower 3-5 bps. "The Spanish syndication is improving sentiment and causing the outperformance of peripheral debt," Natixis rates strategist Jean-Christophe Machado said.

(Reporting by Abhinav Ramnarayan; editing by Saikat Chatterjee and Ed Osmond)