Italy bonds extend relief rally on ebbing political tensions

Fri Oct 4, 2013 7:51am EDT

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By Emelia Sithole-Matarise

LONDON, Oct 4 (Reuters) - Italian bonds rose on Friday, extending this week's relief rally after Prime Minister Enrico Letta's government won a confidence vote in parliament.

Italian debt outperformed low-risk German Bunds in a market seen range-bound as investors weighed the potential consequences of a lengthy U.S. budget standoff on the world's biggest economy.

A partial U.S. government shutdown due to the row has delayed the closely-watched U.S. jobs report, which was due on Friday. The data is a key factor in the Federal Reserve's deliberations over when to scale back its bond purchases.

Any further delays in its release could boost expectations the central bank will maintain the size of its monetary stimulus for longer than initially thought, possibly into 2014.

With scant top-tier data to focus on, markets were looking to political developments in the United States and in Italy, where a Senate committee started a process to expel former premier Silvio Berlusconi from parliament after his tax fraud conviction.

Italian 10-year yields were down 9 basis points at 4.30 percent, back to levels which prevailed early last week before Berlusconi's allies threatened to withdraw from the ruling left-right coalition. Spanish equivalents were 3 bps lower at 4.23 percent.

Italian yields have fallen more than 40 bps this week after members of Berlusconi's centre-right party rebelled against his plan to pull out of the government.

"We are seeing reduced political risk in Italy following relief that Letta survived the no-confidence vote ... We are seeing a bit of short covering in Italian bonds after the sell-off we saw at the start of the week," RIA Capital Markets strategist Nick Stamenkovic said.

Portuguese yields also tracked lower after the country's international lenders approved the country's performance under a bailout in their latest review on Thursday, but rejected government requests to ease fiscal goals.

Some in the market said that while reduced political risks in Italy and successful Spanish auctions on Thursday supported lower-rated euro zone debt, Bunds were unlikely to sell off sharply given the political impasse in the United States.

Lack of progress in ending the partial U.S. government shutdown is feeding worries that lawmakers will not agree a deal to raise the debt ceiling before a mid-October deadline.

While the likelihood of an actual default is seen as slim, there are signs in the market of rising credit risk.

U.S. benchmark yields <US10YT=RR) were, however, up 2 bps at 2.628 percent with German 10-year yields 2.5 bps higher on the day at 1.83 percent. Few in the market expect U.S. and German yields to spike much higher until the standoff in Washington is resolved.

Bund futures were last 25 ticks down at 139.98 as European equities recovered earlier losses going into the U.S. session.

"Liquidity is the dominant factor as regards yield levels and spreads," Rabobank strategist Richard McGuire said.

"The U.S. shutdown on the face of it should be a very clear negative for risk appetite, but in so much as it depresses the outlook for U.S. growth, it also presents a rosier outlook as regards additional stimulus from the Fed."

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