January 11, 2013 / 1:10 PM / 5 years ago

EURO GOVT-Successful debt sale subdues Italy yields

* Italy follows Spain's successful start to 2013 funding
    * Italy 3-yr borrowing costs at lowest in over 2 years
    * Bunds slip after Italy auction, ECB but off 5-week lows


    By Emelia Sithole-Matarise
    LONDON, Jan 11 (Reuters) - Italian bond yields fell on
Friday after a strong debt sale, following euro zone peer
Spain's successful start to the 2013 fund raising programme.
    Italian bonds outpaced low-risk German debt after the
auction of 5 billion euros ($6.6 billion) worth of debt at which
three-year borrowing costs fell below 2 percent for the first
time since March 2010. Markets were also digesting Thursday's
cautiously upbeat message from the ECB. 
    Some strategists, however, warned that further
outperformance against Bunds now looked limited after an
aggressive rally over the past six months sparked by the
European Central Bank's plans to buy bonds of struggling
issuers, if they request conditional aid.
    "The rally has been aggressive and there's still carry to be
had at the front end of Italian and Spanish curves but we're not
so far from levels where at some point investors will try to
re-evaluate the risk/reward of having exposure to Italy," said
Alessandro Giansanti, a strategist at ING.
    Italian 10-year yields were last 3 basis
points lower on the day at 4.14 percent, close to levels last
seen in November 2010, squeezing their premium over Bunds by 3
bps to 258 bps.
    Equivalent Spanish yields were slightly lower
too, having posted their second biggest daily fall in nearly
three months on Thursday after a strong auction which some
strategists said eased pressure on Madrid to seek a bailout in
the next few months.
    
    HURDLES
    Some investors were, however, were starting to have doubts
about the efficacy of adding to their exposure to Spain.
    "Coming into the new year, investors have looked at the
yields available in other so-called risky assets and concluded
that if Spain is guaranteed by the ECB then Spanish bonds are a
very attractive relative investment," Martin Harvey, fund
manager at Threadneedle Investments.  
    "Investors are willing to put the fundamental
vulnerabilities aside for now - at this point we are not," he
said. Threadneedle manages 96 billion euros in assets and its
European bond funds are benchmarked against the Merrill Lynch
pan-European large cap index.
    Spanish bonds make up 5 percent of the index and
Threadneedle's European Bond funds were underweight the index
meaning only 2 percent of their holding is in Spanish government
bonds and all short-dated.
    Low-risk German Bunds steadied on the day as investors were
lured back by higher yields after a sharp sell-off on Thursday
triggered by the ECB's lightly more upbeat view of the euro
zone's economic outlook and dampened bets for an imminent rate
cut.
    The Bund future was last 1 tick up on the day at
142.71 with 10-year German yields unchanged at
1.56 percent, having risen as high as 1.61 percent earlier.
    German two-year yields held at their highest level since
October after ECB President Mario Draghi said policymakers were
unanimous in holding interest rates steady at their meeting on
Thursday
   Traders and strategists said the return of two-year yields
into positive territory could lure back some investors into the
front end of the German curve, given that official interest
rates are set to remain at historic lows for an extended period.
    "Draghi's comments saying the decision on rates was
unanimous and there was no debate on rate cuts is a significant
change from December. But the door is not completely closed to
further rate cuts but the market has to reassess the situation,"
said Patrick Jacq, a rate strategist at BNP Paribas.

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