* Spanish, Italian bonds benefit from better risk appetite
* Italian yields back at pre-Monti resignation plan levels
* Bunds ease, bigger selloff to follow "fiscal cliff" deal
By William James
LONDON, Dec 18 Spanish and Italian government
bonds rallied in thin trade on Tuesday as progress in U.S.
budget talks and the absence of any fresh domestic scares lifted
investors demand for higher-yielding assets.
The prospect of a series of painful automatic austerity
measures next year dimmed slightly when, according to a source
familiar with the talks, U.S. President Barack Obama made a
counter-offer to Republicans that included a change in position
on tax hikes for the wealthy.
That prompted a rally in equities globally and
the desire to secure returns on investment pushed some back
towards the euro zone's lower-rated peripheral bonds as the
effects of last week's political shock in Italy subsided.
This narrowed the yield differential with low-risk German
"We're continuing to grind tighter in the absence of any
negative news. As long as that continues, and equities do well,
we'll continue to see peripherals do well into year-end," a
trader said. "Nobody wants to miss out on the high-yielding
Spanish debt extended gains after its final bill sale of the
year raised more than the target amount. There are no long term
peripheral debt sales until Italy sells bonds on Dec. 28 and the
absence of supply was also supportive, traders
Spanish 10-year bond yields fell 7.5 basis
points to 5.38 percent while the equivalent Italian debt
fell 8 bps to 4.49 percent.
Italian yields moved back below levels seen before Prime
Minister Mario Monti sparked a wave of selling by announcing he
would resign early. Investors have since bought back into Italy
on the view that any successor government will remain committed
to Monti's reform agenda.
SHOW ME THE DEAL
The shift towards riskier assets spurred some investors to
trim their holdings of low-risk debt such as U.S. Treasuries and
German Bunds -- assets used as hedges that should rally if the
U.S. budget talks do not produce a deal.
Bund futures were a fraction lower on the day,
recouping most of their early losses to stand 7 ticks down
versus Monday's settlement, at 144.79.
Traded volume in the Bund future was well below average at
less than 200,000 lots by 1200 GMT with many long-term investors
reluctant to make major changes to their positions before the
new year, leaving trading dominated by more speculative players.
"Euro zone market players -- as much as they are in the
market at all at this time -- want to see this U.S. deal being
closed. They don't want to hear announcements," said Marius
Daheim, chief strategist at Bayerische Landesbank.
"If they see that this problem is off the table, then you
might expect to see a more significant move in Bund yields."
Commerzbank recommended taking short-term positions to
profit from a fall in the Bund future over the course of the
day, targeting the 144 area.
This strategy was also based on comments from the European
Central Bank's Yves Mersch, who told a German newspaper he did
not see the logic of a debate about the bank cutting its main
interest rate from the current record low.