Most euro zone bonds push higher on Fed stimulus outlook

Wed Oct 30, 2013 1:04pm EDT

Related Topics

* German, Italian debt sales meet strong demand

* Fed seen maintaining current stimulus into 2014

* ECB policy outlook also supporting euro zone bonds

By Emelia Sithole-Matarise and Marius Zaharia

LONDON, Oct 30 (Reuters) - Most euro zone bonds firmed on Wednesday with German and Italian debt sales drawing solid demand as investors bet on the U.S. Federal Reserve keeping monetary policy unchanged after its meeting later in the day.

German Bund futures hit new two-month highs as markets rallied on expectations the Fed will maintain its current pace of bond-buying in a bid to prop up an economy damaged by this month's government shutdown in Washington.

A recent run of mixed U.S. economic data has persuaded many in the market that the Fed will keep to its $85 billion a month bond purchases until at least early next year.

"The Fed might be a bit more vocal about taking more time to look at data before tapering. The current environment is very supportive for bonds," said Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers.

The Bund future closed 58 ticks up at 141.85, having hit its highest since August at 141.88 minutes before the end of the trading session. German 10-year yields were 5 basis points down at 1.69 percent.

Earlier, Germany sold 3.4 billion euros of 10-year Bunds with investors bidding for 1.7 times the amount offered, up from 1.3 the last time the paper was auctioned last month, a sign that investors believed the rally could continue.

Some analysts expected a near-term pause, however.

"A lot of this postponed tapering should be priced in already ... so we wouldn't be surprised to see ... a bit of profit-taking," Commerzbank strategist Rainer Guntermann said.

ECB POLICY WAGER

Euro zone bonds across the credit spectrum have also been supported by market speculation that the European Central Bank will ease monetary policy further to support a fragile recovery threatened by a strong euro and curb a rise in money market rates as excess liquidity in the euro system dwindles.

An unexpected slowdown in German annual inflation for October supported such speculation. Euro zone inflation data due on Thursday is expected at 1.1 percent, way below the ECB's close-to-2-percent target.

Analysts say ECB speculation may have been one of the factors behind the strong demand an auction of 6 billion euros of Italian debt where 10-year borrowing costs fell to six-month lows. The sale also benefited from investors ploughing back some of the 24 billion euros in redemption and coupon payments due this week.

Italian 10-year yields were 4 bps up at 4.18 percent as the market absorbed the supply, while equivalent Spanish yields were flat at 4.06 percent. Italian and Portuguese yields were the only ones rising in the region.

"The picture looks supportive going into the ECB meeting, but things might change (after that) ... valuations look a bit stretched," Sunrise Brokers' Ziglio said.

Spain has outperformed Italy in the past week with investors encouraged by data showing the Iberian country exited a two-year recession in the third quarter thanks to strong exports.

Barclays strategists say Spanish yields could trade 20 to 30 bps below Italian equivalents in coming days, arguing that Spain's economic prospects in coming months look more positive, with Madrid well ahead of Rome with structural reforms.

But they said this outperformance could peter out later as Italy still benefits from a more liquid debt market which made it the portfolio choice for foreign investors.

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