Italian Bonds Slide Showing ECB QE Doesn’t Justify One-Way Bet

After the start of the European Central Bank’s quantitative easing pushed bond yields to record lows, trading this week showed that market logic hasn’t been completely turned on its head. Rates can also rise.

Price declines pushed Italian 10-year yields to their first weekly increase in more than a month, halting a rally that was fueled by the anticipation, and the implementation, of ECB purchases on March 9. The spark was a 15-year debt offering that was bigger than some investors anticipated, stoking speculation that countries would flood the market, just as traders were awaiting the Federal Reserve’s latest policy statement. By the end of the week, Italy’s bonds pared the drop amid signs of progress in Greece’s negotiations with creditors.

“Having had a fairly good run heading into and post the onset of QE, I think some money was taken off the table and that is why we saw peripheral spreads widen,” said Richard McGuire, head of European rates strategy at Rabobank International in London. “It’s not a linear process. The key pivot point was the Fed meeting and that coincided with the Italian 15-year syndication, which is one reason why that issuance weighed as it did,” he said, referring to Italy’s debt sale via banks.

Italy’s 10-year yield rose five basis points, or 0.05 percentage point, this week to 1.20 percent as of 5 p.m. London time on Friday. That’s the first increase since the period ended Feb. 13. The 2.5 percent bond due December 2024 fell 0.55, or 5.50 euros per 1,000-euro ($1,085) face amount, to 111.855.

Friday Recovery

The rate dropped five basis points on Friday, halving its increase since March 13. Similar-maturity Spanish yields rose three basis points in the week to 1.18 percent.

In addition to Italy's debt sale, concern that the Fed would be aggressive in signaling higher U.S. interest rates combined with Greece’s turmoil to reduce demand for lower-rated bonds, even as the ECB stood ready to buy the region’s sovereign debt.

The extra yield, or spread, that investors get for holding Italian 10-year securities instead of similar-maturity German bunds rose to 118 basis points on Wednesday, the most since Feb. 23, before narrowing to 102 basis points two days later. The equivalent Spanish-German spread ended the week at 100 basis points, having been at 114 basis points on March 18, the widest since Feb. 20.

‘Spread Dynamics’

“We regard the recent spread dynamics as temporary and expect the tightening momentum to resume,” Markus Koch, a strategist at Commerzbank AG in Frankfurt, wrote in a client note yesterday. “We stick with our strategic spread targets,” he wrote, citing 65 basis points as the goal for the Spanish-German 10-year spread.

The securities rallied Friday as a European Union official told reporters in Brussels that Greece could win an infusion of bailout money as soon as next week if Prime Minister Alexis Tsipras can deliver an adequate package of reform measures. German Chancellor Angela Merkel reaffirmed her commitment to keeping Greece in the euro area, saying she hadn’t “entered into this debate” about it leaving.

Greek bonds pared a weekly decline on Friday with the three-year yield falling 237 basis points to 21.37 percent, having climbed to 25.70 percent earlier that day, the highest since the nation’s debt was restructured in 2012. The 10-year rate fell 65 basis points on Friday to 11.35 percent, having increased to more than 12 percent for the first time since April 2013 a day earlier.

Still, with short-term rates higher than those on longer-dated debt, Greece’s inverted yield curve may indicate investors are concerned they may not be repaid in full.

Germany’s 10-year bund yield fell seven basis points this week to 0.18 percent, having touched a record-low 0.168 percent on Friday. The nation’s 30-year yields dropped nine basis points to 0.63 percent and reached a record 0.603 percent on March 19.

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