* Italian, Spanish politics watched closely
* German five-year debt sale finds strong demand
* Markets, especially in periphery, could face volatility
By Marius Zaharia
LONDON, Feb 6 Bunds firmed on Wednesday, with a
five-year debt auction pointing to strong demand for assets
perceived as safe havens after a recent flare-up of concern over
political stability in Spain and Italy.
The sale was also helped by this year's rise in yields due
to expectations that excess liquidity in the banking system will
shrink faster than initially thought as banks repay large sums
in emergency loans to the European Central Bank.
Investors snapped up 3.27 billion euros of the paper at an
average yield of 0.68 percent, 15 basis points higher than when
it was first launched in February.
"Today's good demand at the five-year auction is a sign that
the recent political instability in the (euro zone) periphery
played a major role in re-direction of some flows into
safe-haven paper," said Annalisa Piazza, market economist at
In Spain, Prime Minister Mariano Rajoy is facing pressure to
quit due to a corruption scandal, in which he denies any
wrongdoing. In Italy, former premier Silvio Berlusconi is
gaining ground in pre-election polls, raising worries the recent
progress in structural reforms there could be reversed.
Robin Marshall, fixed income director at Smith and
Williamson securities, said the lack of prospects of further
easing in ECB policy at a time when other major central banks
are printing large amounts of money also made German debt
attractive from a currency perspective for overseas investors.
"There's not a great deal of value in the short-end
yield-wise but with the currency strength you could argue
there's reasonable value ... and if things do blow up (in the
periphery) then Bunds should be fine," said Marshall, who helps
manage about $18 billion.
The ECB meets on Thursday and debt traders said they would
watch for any sign President Mario Draghi may soften his tone on
monetary policy given the recent strength in the euro currency.
Bund futures were last 37 ticks higher on the day
at 142.57, with 10-year yields down 3 basis points
at 1.63 percent and five-year yields falling 2.3
bps to 0.685 percent.
Italian and Spanish debt were steady across all maturities,
with their 10-year benchmarks trading at 4.50 percent
and 5.39 percent, respectively.
Both sets of bonds sold off sharply at the start of this
week, and even if they showed signs of stabilising after
Tuesday's better than expected euro zone business surveys,
analysts say selling pressure may return soon.
"Market participants see the risk that the Rajoy government
can collapse on this scandal and you can't know whether the next
person will have the courage to continue (his reforms)," said
Marius Daheim, chief strategist at Bayerische Landesbank.
"Also you can't ignore that Berlusconi has said that if his
party comes to power there will be no more austerity ... On the
other hand the economic picture seems to brighten up and (the
ECB's new bond-buying programme) is still providing a backstop."
He said the mixed picture would keep Bund yields stuck in
their narrow recent range of 1.63-1.72 percent and Spanish
yields in a wider 5.00-5.50 percent band near-term, while
investors await more conclusive political developments.
Commerzbank strategists described the recent stabilisation
as the potential "calm before the periphery storm" and
recommended investors sell Italian and Spanish bonds.