EURO GOVT-Spain and Italy edge up but rocky road lies ahead

Tue Feb 5, 2013 7:22am EST

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* Spanish and Italian yields stabilise after Monday selloff
    * Outlook to remain volatile as political risks rise
    * Safety bid for Bunds eases on peripheral recovery and data


    By William James and Ana Nicolaci da Costa
    LONDON, Feb 5 (Reuters) - Spanish and Italian bonds inched
up on Tuesday after a steep selloff in the previous session,
with the near-term outlook for both countries expected to be
volatile as political risks rise.
    Their yields edged lower as markets took stock of corruption
allegations putting pressure on Spanish premier Mariano Rajoy
and growing uncertainty over how upcoming elections in Italy
might pan out.
    Spanish 10-year yields fell 3 bps to 5.41
percent and Italian yields were down 4.3 bps at
4.44 percent. Both had risen 20 basis points on Monday.
    "The market was simply waiting for some kind of catalyst to
switch to a risk-off mood and take some of the profits that had
accumulated in January when we saw a very bullish tone in the
market," said Christian Lenk, strategist at DZ Bank.
    The modest rebound from Monday's selling indicated that the
underlying positive mood towards riskier debt was unlikely to
dissipate yet, but trading could be more volatile in coming
weeks.
    Barclays Capital analysis on Spain, using proprietary and
central bank data, showed that foreign investors who deserted
the Spanish market last year had returned and much of the
betting against Madrid had been scaled back.
    "The broad stabilization over the past month, coupled with
renewed bouts of limited pressure, are likely to be the 'new
normal' for the coming months at least," the bank said.

    RELATIVE PLAY
    The improved performance in peripheral debt eased demand for
the safety and liquidity of German debt. Bund futures 
slipped nearly half a point to 142.18 - wiping out much of the
gains made on Monday.
    Better-than-expected euro zone data also eased pressure with
a business activity survey showing that the region is probably
recovering, albeit driven in large part by
Germany. 
    Later in the session, investors will look at data from the
U.S. services sector to gauge the Federal Reserve's monetary
policy outlook after recent releases have painted a mostly
upbeat picture of the world's largest economy.
    "At the moment, I think there is a kind of decoupling
between the U.S. and Europe and therefore I think the Bund can
outperform Treasuries," BNP Paribas strategist Patrick Jacq
said.
    "This has to do with the economic situation in the U.S. and
also the fact that risks are re-emerging in Europe. This is
offering Bunds stronger support and therefore it makes sense to
see an outperformance."
    The yield spread between 10-year U.S. Treasuries 
and the German equivalent stood at 34 basis points, little
changed from the previous session but wider than the 29 bps in
late European trading on Friday.
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