EURO GOVT-Spain and Italy rebound but rocky road lies ahead

Tue Feb 5, 2013 11:37am EST

Related Topics

* Spanish and Italian yields dip after Monday selloff
    * Outlook to remain volatile as political risks rise
    * German yield rise should help secure smooth auction


    By William James
    LONDON, Feb 5 (Reuters) - Spanish and Italian bonds
rebounded on Tuesday after a steep selloff in the previous
session, signalling the start of what analysts expect will be a
volatile period fuelled by political uncertainty.
    Yields on both countries' debt dipped as markets took stock
of corruption allegations in Spain, which are pressuring 
premier Mariano Rajoy, and of growing uncertainty over how
upcoming elections in Italy might pan out.
    Spanish 10-year yields fell 8 bps to 5.37
percent and Italian yields slipped 3.3 bps to 4.45
percent. 
    Both yields had risen 20 basis points on Monday in one of
the steepest selloffs of peripheral bonds since before the
European Central Bank's pledge to buy struggling states' bonds
if needed calmed markets.
    "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.
    Lenk said the modest rebound on Tuesday indicated that the
underlying positive mood towards riskier debt was unlikely to
dissipate yet.
    But, analysts said trading could be more volatile in coming
weeks.
    Former Italian Prime Minister Silvio Berlusconi, who left
office in 2011 with Italy facing a Greek-style debt crisis, has
been gaining in polls, causing jitters among investors who fear
the country's reform agenda may be compromised. 
    Similarly, any sign that the corruption scandal in Spain
could force Rajoy, who denies any wrongdoing, from office would
be a blow to the country's prospects of escaping recession and
funding itself without official support. 
    A 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 142.23 - wiping out much of the
gains made on Monday.
    Above-expectation euro zone data also eased pressure with a
business activity survey showing the region is recovering,
albeit driven in large part by Germany. 
    Traders said the rise in German bond yields across the curve
 was likely to ensure a smooth auction of
five-year debt on Wednesday.
    "German yields are far less repulsive than they were at the
back end of last year and we certainly feel as though you will
see some decent demand for German paper here," a trader said.
    "Bank treasuries and central banks would much rather hold
(German) Bobls here than (French) BTANS given the yield
compression we've had."
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