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Top-rated bonds underperform periphery in broad Fed-led selloff
March 20, 2014 / 12:25 PM / in 4 years

Top-rated bonds underperform periphery in broad Fed-led selloff

* Yellen signals rate hikes might come sooner than expected

* Yields rise, but low-rated bonds outperform

* French, Spanish bond auctions go smoothly (Updates with debt auctions, fresh comments)

By Marius Zaharia

LONDON, March 20 (Reuters) - Top-rated euro zone debt underperformed peripheral bonds on Thursday in a broad sell-off triggered by the U.S. Federal Reserve signalling it could raise interest rates sooner than many had thought.

In her first news conference as the head of the U.S. central bank, Janet Yellen said the Fed would probably end its bond-buying stimulus programme this autumn and could start raising rates six months later.

The comments pushed German 10-year Bund yields , the benchmark for euro zone borrowing costs, up 6.5 basis points to 1.66 percent. Finnish, French, Dutch and Austrian yields also rose 6 bps or more.

Yields on Spanish bonds, which would have normally underperformed their peers as investors made room for the bond auctioned earlier in the day, rose 3.8 bps to 3.38 percent. Italian yields rose 4.5 bps to 3.435 percent, while Portuguese yields fell.

Analysts took the move in bond markets as an indication that the Fed’s exit from the ultra-loose monetary policy which has underpinned various asset classes across the globe in recent years was unlikely to rekindle debt market tensions in the region’s weaker states.

It also highlighted market expectations that the European Central Bank may still take the opposite route and ease monetary policy further to boost inflation - a stance that has supported the appetite for high-yielding euro zone assets.

“The pattern seems to be of investors basically switching from emerging market risk to peripheral risk but not necessarily away from risk,” said Elwin de Groot, market economist at Rabobank in Utrecht. “The potential for further ECB accommodation is still ... (tightening yield) spreads.”

Daniel Lenz, lead market strategist for the euro zone at DZ Bank in Frankfurt, said that in an environment of rising yields across the board investors would be better off in Italy and Spain as those markets offered higher absolute returns than core markets.

Underlying the still upbeat investor sentiment in the periphery, a Spanish auction of 5 billion euros of 2017, 2019 and 2028 bonds saw better demand than previous sales, while average borrowing costs fell to pre-crisis lows for two of the bonds.

SO SPECIFIC

When analysts predicted at the end of last year that top-rated euro zone bond yields would rise in 2014, they cited the Fed’s gradual policy shift as the key reason. But Bund yields have actually fallen 35 bps this year, leaving many doubting a major trend reversal is imminent.

“What she (Yellen) said about the first rate hike - markets certainly didn’t expect her to be so specific,” said Jussi Hiljanen, chief fixed income strategist at SEB in Stockholm.

“But it is too early for a turnaround in the yield trend. In Europe, low inflation is a key thing and the risk - or possibility, depending on how you’re positioned - is of more action from the ECB.”

Apart from the ECB outlook, tensions between the West and Russia over the Black Sea region of Crimea and an emerging market sell-off earlier this year, have contributed to keeping Bund and other core yields low so far in 2014.

A French bond auction earlier on Thursday went smoothly. Analysts said the rise in yields prior to the sale attracted bidders in what was also taken as a sign that investors did not foresee a major sell-off in European debt. (Editing by Nigel Stephenson)

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