* Italian bonds fall after Fitch downgrade
* German Bunds benefit from Italian backdrop
* Some analysts say markets too complacent on Italy
By Marius Zaharia and Ana Nicolaci da Costa
LONDON, March 11 Italian government bonds
underperformed other euro zone debt on Monday after Fitch cut
the country's credit rating, but the move was contained by the
U.S. economic outlook and investors hunting for yield.
Markets are split on the outlook for Italian bonds. Some
analysts say the European Central Bank's so far untested
bond-buying programme will protect them against a sell-off,
while others say a political deadlock there could eventually
bring it to the forefront of the euro zone crisis again.
Fitch's one-notch downgrade to BBB-plus with a negative
outlook pushed 10-year Italian yields 7 basis
points higher on the day to 4.66 percent, well below highs of
just under 5 percent hit at the end of February.
"The market is fairly OK with the downgrade. (Italian bonds)
have shown quite a lot of resilience. These are fairly good
levels for what's going on in Italy," said David Schnautz, rate
strategist at Commerzbank in New York.
"We still have no clear guidance over how the situation will
evolve over the next weeks, months, maybe quarters on the policy
front. It is not the time to expect any structural reforms out
Commerzbank turned negative on Italian bonds after the
February elections produced a hung parliament but closed its
selling recommendations last week because "we didn't want to
stand in front of the train any more," Schnautz said.
Traders said many investors who sold Italian debt prior to
or after the elections were coming back to the market as yields
became more attractive. Yield-hunting has been a feature of euro
zone bond markets for much of this year, with investors
encouraged by upbeat U.S. data and the ECB's backstop.
"(Investors) are confident on the overall effectiveness of
the ECB's safety net," Ricardo Barbieri, strategist at Mizuho
said, pointing to the subdued reaction of Spanish bond markets
to the political crisis in Italy.
Spanish 10-year bonds have mostly outperformed
Italian debt since the elections with the 10-year yield spread
between them hitting its narrowest since March 2012 at 8 bps, a
tenth of the gap at the beginning of the year.
Data on Friday showing U.S. employers added a
greater-than-expected 236,000 workers to their payrolls in
February also prevented a deeper sell-off in Italian debt and
other high-yielding assets.
The appetite for Italy's debt will be tested again at a
sale this week. Despite the downgrade, analysts expect
yield-hungry investors to post solid bids for the bonds as they
have done at recent Italian and Spanish bond auctions.
"I am sure it will go relatively well," Cyril Regnat, fixed
income strategist at Natixis said.
But he said optimism towards lower-rated debt was overdone.
"The market is probably too optimistic regarding Italy and
even more regarding Spain," he said.
"Italian and Spanish debt are really expensive. We would
wait to enter longer positions on both debt - right now, it's
too risky given these uncertainties on the political side."
Safe-haven German Bund futures were up 21 ticks on
the day at 142.67, while 10-year cash yields were
1.8 basis points lower at 1.508 percent.