Euro zone bonds rise after Summers drops Fed candidacy

Mon Sep 16, 2013 12:58pm EDT

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* Portuguese bonds in focus as bailout review gets underway

By Ana Nicolaci da Costa and Emelia Sithole-Matarise

LONDON, Sept 16 (Reuters) - Euro zone bond prices rose on Monday after Lawrence Summers, widely seen by financial markets as less committed to ultra-loose monetary policy, withdrew from the race to head the U.S. Federal Reserve.

Euro zone debt rose across the credit spectrum as investors bet Summers' withdrawal eased the risk of a Fed leadership that would rein in its programme of support for the economy faster next year than currently expected.

The other leading candidate to head the central bank, Fed deputy chief Janet Yellen, is seen by markets as likely to be more supportive of existing policy and less likely to scale bond purchases back quickly and raise rates.

Summers' decision comes just before the Fed meets this week to decide when and by how much to trim its asset purchases from the current pace of $85 billion a month.

"The timing of Summers' withdrawal took markets by surprise and the rally in Treasuries has given a boost to Bunds and gilts," said RIA Capital Markets strategist Nick Stamenkovic.

"That clearly makes Janet Yellen front runner for new Fed chairman. She is known as a key supporter of QE and the market is taking the view that interest rates will be kept lower for longer."

The Bund future was up 51 ticks at a settlement close of 138.50 with German 10-year yields down 2.8 basis points at 1.895 percent.

U.S. Treasuries outpaced their German counterparts, squeezing the 10-year T-note yield premium over Bunds by 5 bps to 87 bps.

German 10-year yields have pulled further away from a 1-1/2-year high of 2.059 percent hit on Sept. 6, as mixed U.S. economic data clouded the outlook on how fast the Fed would scale back its monetary stimulus.

By late trade, riskier periphery bonds outperformed. Italian 10-year yields were down 8.6 basis points at 4.48 percent and Spanish equivalent were 7 basis points lower at 4.43 percent.

"With this ... withdrawal of Larry Summers from the Fed race, the market is pricing in a more dovish Fed going forward and this of course is helping the whole periphery," Alessandro Tentori, global head of rates strategy at Citi said.

Italian bonds outperformed Spanish ones, tightening the yield spread between the two by 4 basis points to 3 basis points.

Italian yields overtook their Spanish counterparts for the first time in 18 months last week due to political uncertainty.

Allies of Silvio Berlusconi have been threatening for weeks to bring down the left-right coalition of premier Enrico Letta if a Senate committee meeting this week votes to bar him from parliament.

In recent days, political sources have suggested the centre-right leader is backing away from an immediate government crisis and elections for fear this could misfire while an opinion poll on Monday showed Silvio Berlusconi's party falling behind its centre-left rivals.

"You have the fact that the country has heavily underperformed the likes of Spain over the last two weeks... and there's maybe some speculation that the vote on Berlusconi will not (lead to) a government collapse," Tentori said.

Portuguese bonds rebounded, having fallen earlier in the day, pushing yields 13 basis points lower to 7.32 percent.

The country however remained vulnerable as investors fretted about Lisbon's relationship with its international backers.

For the first time since Portugal received its bailout in 2011, European Union and International Monetary Fund officials arriving on Monday will have to deal with new Deputy Prime Minister Paulo Portas, who nearly brought down the government in July by challenging the pain of austerity measures.

Portugal may seek a precautionary loan deal when its bailout ends next year, Portas said on Monday, but would seek to avoid following Greece into a second rescue.

"At the end of the day, what counts is that you have a country that has maybe underperformed more than others and once the risk-on (takes hold) people just look at what's cheap and buy that," Tentori added, explaining the rebound in Portugal.

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