December 18, 2012 / 5:26 PM / in 5 years

EURO GOVT-Progress on U.S. budget talks lifts peripheral debt

* Spanish, Italian bonds benefit from better risk appetite
    * Italian yields back at pre-Monti resignation plan levels
    * Bunds ease, look prone to further falls

    By William James and Marius Zaharia
    LONDON, Dec 18 (Reuters) - Spanish and Italian bonds rallied
on Tuesday as progress in U.S. budget talks and the absence of
any fresh domestic scares lifted investor demand for
higher-yielding assets and weighed on safe-haven Bunds.
    The prospect of a series of painful automatic austerity
measures in the United States next year dimmed slightly when,
according to a source familiar with the talks, 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 investment returns pushed some back towards the euro
zone's lower-rated peripheral bonds as the effects of last
week's political shock in Italy subsided. 
    That narrowed the yield differential with German debt.
    "Certainly one thing that's clear is that news in the U.S.
is getting better and better," DZ Bank strategist Christian Lenk
    "Everybody is looking for yield these days, if you want to
have something in the euro zone you will buy Spain and Italy.
Maybe the lack of bad news is sufficient for some investors to
buy them."
    Spanish debt extended gains after Madrid's final bill sale
of the year raised more than the target amount. There are no
long-term peripheral debt sales due until Italy sells bonds on
Dec. 28 and the lack of supply was also supportive, traders
    Spanish 10-year bond yields fell 12 basis
points to 5.33 percent while the equivalent on Italian debt
 fell 11 bps to 4.46 percent.
    Italian yields moved back below levels seen before Prime
Minister Mario Monti sparked a wave of selling last week after
announcing he would resign early. Investors have since bought
back into Italy on the view that any successor government would
remain committed to Monti's reform agenda.
    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 47 ticks lower on the day at
144.36, while 10-year cash yields were 4.1 basis
points higher at 1.412 percent.
    The break through 144.54, the 62 percent Fibonacci
retracement of the November-to-December rally opened the way
towards 143.53, the lows seen late last month, according to
Richard Adcock, a technical strategist at UBS.  
    DZ Bank's Lenk said the technical picture for Bunds
suggested there was potential for further falls. The session
lows have been falling for the past six sessions, including on
    Budget talks in the United States may weigh on Bunds if
successful, but a sharp, sustained falling trend is unlikely. A
grim global economic outlook for next year was expected to bring
in buyers on any price dips.
    "The market is trying to get a positive spin on things at
the moment. It shows that people want to believe," said Peter
Allwright, head of absolute return on rates and currency at RWC
Capital Markets.
    "But there's still going to be some tightening. It's still
going to be a source of contraction, even if they do a deal."
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