Italy, Spain bonds shine as Ukraine crisis heats up

Wed Apr 16, 2014 7:49am EDT

* Periphery's yields dip amid Ukraine tensions

* Investors see Spain, Italy as new sweet spot

* Returns appeal as shock risks diminish (Adds quotes, details)

LONDON, April 16 (Reuters) - Italian and Spanish bond yields hovered around multi-year lows on Wednesday, offering relatively safe, high returns that attracted investors with one eye on the developing crisis in Ukraine.

Investor confidence in the euro zone's rehabilitation and the potential for ECB asset purchases have cushioned the debt of the peripheral countries against geopolitical shocks.

"Italian and Spanish bonds are now the sweet spot within euro zone debt markets," said Sandra Holdsworth, an investment manager at Kames Capital.

Yields on both countries' 10-year bonds dipped 1 basis point, Italy's to 3.11 percent and Spain's to 3.09 percent. German Bund yields rose 2 bps to 1.49 percent, and demand was tepid for its 10-year auction on Wednesday.

Foreign investors who shunned peripheral countries at the depths of the eurozone sovereign debt crisis are now much more optimistic about their prospects.

"At least in the case of Spain, the market is responding to the correction of the (economic) imbalances, the reform effort and the results in fiscal consolidation," Pablo de Ramon-Laca, head of funding at the Spanish treasury, told Reuters on Tuesday.

The Italian government's reform agenda came in for criticism this week, prompting the European Commission to remind Italy it was committed to balancing its budget. But data from the Bank of Italy showed foreign investors were returning en masse. And a sale of inflation-linked bonds to domestic retail investors will close early on Wednesday after orders approached 10 billion euros.

SHOCK RESISTANT

With the European Central Bank standing ready to nurture growth in the euro zone with radical measures such as quantitative easing, investors are confident peripheral debt is now almost immune to outside shocks.

"The issue of Russia doesn't necessarily affect one's opinion on Spain repaying their debt, which was the case a few years ago. Our fixed income team said (any rise in yields on the back of that) would be an opportunity to buy more," said Bill Street, head of EMEA investments at State Street Global Advisers.

The total returns are also appealing. So far this year, Italian bonds have returned 6.3 percent and Spanish bonds 6.7 percent, around double the 3.2 percent returns on German paper, according to Citi's World Government Bond Index.

Many predict that the spread they offer over German yields will continue to fall. Banks such as RBS and Credit Agricole expect a difference of just 100 bps by the end of the year from around 160 bps at present.

"It has been an extraordinary rally. It's all been steady and completely one-way," said Holdsworth at Kames. "It's very similar to the convergence that occurred before the euro came into existence back in the late nineties."

Sovereign debt managers are able to take advantage of this cheap, and readily available, market funding to dedicate more time to managing their debt profiles. Spain said on Tuesday it may use such things as bond switches and buy-acks to soothe nvestor worries about their abilities to meet hefty repayments in years ahead.

More than half of Spain's 914 billion euro ($1.26 trillion)debt matures within the next four years, according to Thomson Reuters data. (Editing by Larry King)

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