Core euro zone bonds rise after U.S debt deal

Thu Oct 17, 2013 8:05am EDT

Related Topics

* Temporary nature of deal a worry, seen delaying Fed tapering

* Strong Spanish sale shows demand for country's bond still strong

* France also sees firm demand at auction

By Ana Nicolaci da Costa

LONDON, Oct 17 (Reuters) - High-rated euro zone debt rose on Thursday as a temporary deal to avoid a U.S. debt default was seen providing only fleeting respite, while being likely to delay moves by the Federal Reserve to scale back bond purchases.

The overnight deal did not resolve fundamental differences over spending and deficits between Republicans and Democrats, funding the government only until Jan. 15 and raising the debt ceiling until Feb. 7.

Those divisions were reflected in credit default swap prices. One-year CDS is down more than 20 basis points from last week's highs, but the cost of insuring against a U.S. default over that period remains higher than over five years, suggesting "tail-risk" has yet to be fully priced out.

It is normally costlier to buy longer-term credit protection.

Among higher-yielding paper, ongoing healthy demand for Spanish paper extended to a strong auction at which the Madrid treasury sold 2.54 billion euros of bonds - above the targeted amount as medium-term debt costs fell.

The U.S. backdrop was supportive, analysts said, but also noted that recent demand for euro zone peripheral debt has generally been driven by improved economic forecasts and hopes for further liquidity from the European Central Bank.

"They have kicked the proverbial can down the road and U.S. fiscal negotiations will restart early next year. Consequently it's going to be very difficult for the Fed to taper at that time," Nick Stamenkovic, bond strategist at RIA Capital Markets said.

"As a result the market is increasingly confident that a reduction of QE (quantitative easing) is unlikely to be on the agenda until well into 2014. So that's given Treasuries a boost and that's filtered through to Bunds."

German Bund futures jumped 48 ticks to 139.39, pushing 10-year German yields 4.3 basis points lower to 1.89 percent.

They played catch-up with U.S. yields which have fallen more than 10 basis points from the previous day's highs. U.S. yields were down 4 basis points at 2.63 percent.

The yield spread between ten-year U.S. Treasuries and equivalent German Bunds tightened 8 basis points to 72 bps.

"Is it good that they have got a deal out of the way for Treasuries? I suppose it is (because) they are not going to go bust," one trader said. "It's only a short-term thing, it runs out in January, February time."

IN DEMAND

Other higher-rated euro zone debt also rose, as France saw strong demand for its bonds at two auctions.

The euro zone's second-largest economy has been steadily attracting good demand for its bonds despite sluggish growth and delays in its deficit and debt targets, as it offers better returns than Germany.

Ten-year French government bond yields were 2.5 basis points lower at 2.41 percent. Ten-year Dutch yields were 2.7 basis points down at 2.27 percent and Austrian yields eased 2.1 bps to 2.29 percent.

In Madrid, there was strong demand for the three-year and five-year bonds on offer, with the shorter yield falling to its lowest since April 2010 and the longer one to its lowest rate since it was first sold in July.

In the secondary market, ten-year Spanish and Italian yields were flat at 4.30 percent and 4.24 percent respectively.

"Overall, it's a fairly solid auction but also we have to keep in mind that it's not a huge surprise, because the auction size was small in the first place and we had a budget deal in the U.S so some positive momentum here for sentiment," Michael Leister, senior interest rate strategist Commerzbank said.

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