Italian Bonds Drop on Bets Rally Overdone as Pimco Cuts Holdings

Italy’s bonds fell for a second day as Pacific Investment Management Co. said it lowered its holdings, fueling bets a rally that took 10-year yields below 4 percent for the first time since November 2010 was excessive.

Spanish bonds also declined, pushing 10-year yields up by the most in four weeks, after a report showed unemployment in the nation climbed to a 37-year high. Pimco reduced its holdings of Spanish and Italian government debt after the securities rallied, the company said yesterday. European Central Bank Executive Board member Joerg Asmussen said interest-rate cuts would have limited effect on the euro-region’s periphery. German bunds were little changed.

“What we’ve heard from the Italian clients we speak to is that they have taken a little bit of money off the table once 10-year Italian bonds had tested the psychologically important 4 percent level,” said Richard McGuire, a senior fixed-income strategist at Rabobank International in London. “It’s not surprising to see in the wake of the relatively pronounced additional rally in peripherals.”

Italy’s 10-year yield rose five basis points, or 0.05 percentage point, to 4.06 percent at 4:15 p.m. London time, after dropping to 3.89 percent on April 23, the lowest level since October 2010. The 5.5 percent bond maturing in November 2022 fell 0.41, or 4.10 euros per 1,000-euro ($1,301) face amount, to 111.625.

Enrico Letta, the 46-year-old deputy secretary of Italy’s biggest political party, was designated prime minister yesterday after eight weeks of political deadlock.

‘Credit Risk’

A year-and-a-half after resigning, Silvio Berlusconi became the key figure in talks that began today to form the next Cabinet after Letta’s appointment. Berlusconi and his 241 lawmakers, the second-biggest contingent, hold the votes the Democratic Party’s Letta needs to secure a parliamentary majority.

Newport Beach, California-based Pimco trimmed its holdings of Spanish and Italian securities starting last month, Andrew Balls, the London-based head of European portfolio management said in a telephone interview yesterday.

“We’ve been reducing credit risk in our portfolios and in recent weeks we’ve cut Italy and Spain,” Balls said. There’s “no significant change in the outlook but the bonds have rallied a lot so we’ve sold some recently.”

The number of unemployed in Spain increased to more than 6 million for the first time, climbing to 27.16 percent of the workforce in the first quarter, compared with 26.02 percent in the previous three months, the National Statistics Institute in Madrid said today.

Spanish Rates

Spain’s 10-year yield rose one basis point to 4.30 percent after climbing as much as 13 basis points, the most since March 27. The rate fell to 4.215 percent yesterday, the lowest since November 2010.

German 10-year bunds yielded 1.24 percent. The rate slid to 1.19 percent on April 23, the lowest since July 24.

The ECB will reduce its main refinancing rate by 25 basis points to 0.5 percent at its next meeting on May 2, according to 27 of 45 economists in a Bloomberg News survey. The others predict no change.

UBS AG, Rabobank International, Nomura and Royal Bank of Scotland Group Plc (RBS) all changed their forecasts yesterday to predict the ECB will cut interest rates after a report this week showed euro-area output contracted for a 15th month.

Rate Cuts

“The pass-through of rate cuts to the periphery would be limited, and this is where they are most needed,” Asmussen said in London today, according to the text of a speech provided by the ECB. “At the same time, rate cuts would further relax already unprecedentedly easy financing conditions in the core. This is not per se a problem -- but interest rates that are too low for too long can eventually lead to distortions.”

The ECB has room to ease monetary policy further, David Lipton, first deputy managing director of the International Monetary Fund, said in London today.

German bonds returned 0.9 percent this year through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italian securities gained 3.8 percent and Spanish debt earned 7.3 percent.

Volatility on Italian bonds was the highest in euro-area markets today followed by those of the Netherlands and Ireland, according to measures of 10-year debt, the yield spread between two- and 10-year securities, and credit-default swaps.

To contact the reporters on this story: Lucy Meakin in London at lmeakin1@bloomberg.net; David Goodman in London at dgoodman28@bloomberg.net

To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net

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