EURO GOVT-Faith in ECB backstop helps Italian bonds recover

Thu Feb 28, 2013 4:05am EST

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* German Bunds dip, Italian debt rebounds further
    * ECB backstop seen as crucial to current market calm
    * Heavy long bias towards periphery creates selloff risks

    By William James
    LONDON, Feb 28 (Reuters) - Italian bonds pared recent losses
on Thursday as investors took stock of the country's political
stalemate, with concerns over possible fresh elections offset by
the European Central Bank's bond-buying backstop.
    The political crisis following indecisive election results
in Italy deepened on Wednesday when two party leaders ruled out
the most likely options to form a government, raising the
chances of a fresh vote. 
    But, the ECB's longstanding promise to buy bonds issued by
struggling states if needed has helped to limit the selloff in
Italian bonds, and was expected to continue doing so over the
near term.
    Italian 10-year bond yields were 6 basis
points lower at 4.76 percent while Bund futures fell 21
ticks versus Wednesday's settlement to 144.88. A recovery in
equities also signalled the more positive market sentiment.     
    "There will be a risk premium on Italian yields until a new
government is formed and we know what they're going to do with
structural and fiscal reforms," said Nick Stamenkovic,
strategist at RIA Capital Markets in Edinburgh.
    "But, we're not going to see a return to the levels we saw a
year ago because the ECB has pledged to use its balance sheet if
necessary."
    Italian 10-year yields have now pared around 15 basis points
of the 50 basis point rise seen earlier this week. Current
yields are well above lows near 4.12 percent hit in January, but
also far below the levels above 6 percent seen in mid 2011.
    
    SELLOFF RISKS PREVAIL
    Nevertheless, bond markets' risk-hungry start to the year,
when investors loaded up on higher-yielding debt from across the
region's struggling peripheral states, has left many exposed to
further weakness in Italian BTP bonds.
    "Anyone who bought BTPs this year is now offside," a trader
said. "Given the positioning in periphery, which is radically
longer than it was six months ago, that doesn't really support
things."
    The heavy bias this year towards betting on a rise in
Italian bonds means that any fall in prices leads to lower
profits or even outright losses for investors, giving a strong
incentive to sell out quickly if the situation worsens - a
potential snowball effect that could benefit German debt.
    "We continue to maintain a positive view on Bunds, with the
view that yields go to 1.25 percent and possibly beyond," the
trader said.
    Ten-year German yields were last at 1.47
percent, up 2 basis points on the day but still close to
two-month lows hit on Wednesday at 1.42 percent.
    Concerns over major U.S. spending cuts due to start taking
effect on Friday also gave background support to low risk bonds,
although analysts said the impact would be felt over the medium
term and was currently overshadowed by euro zone problems.
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