EURO GOVT-Bunds fall on ECB bond buying expectations

 

Spanish sovereign bonds rallied on Monday as traders focused on the prospect of the ECB intervening in bond markets to help contain the borrowing costs of troubled sovereign debtors.

A report from German magazine der Spiegel saying the ECB is considering setting interest rate thresholds for any purchases of struggling euro zone country's bonds underpinned the Spanish debt market in early trade and prompted a fall of a point in the German Bund future, according to traders.

An ECB spokesman later said it was misleading to report on views which have not yet been discussed by the ECB's Governing Council, prompting Spanish yields and the Bund contract to gradually come off the day's lows..

But Spanish yields were still decisively down on the day in late European trading on expectations that some central bank policy response was forthcoming, possibly in September.

"It is outside the mandate," to specifically target certain yield levels, Luca Jellinek, head of European rates strategy at Credit Agricole said.

"But don't forget there has been a constant drift on that point. If somebody told you in 2007 the ECB was going to buy government bonds in the open market, you would have just laughed in their face."

He expected the recent bond rally to provide a favorable backdrop for a sale of Spanish bills on Tuesday, and result in lower yields and a decent bid-cover at the auction.

Ten-year Spanish yields were down 16 basis points at 6.33%, having fallen more than 20 basis points earlier in the day.

The cost to Spain of borrowing over five years fell 17 bps to 5.23%, while the two-year yield was 9.8 bps lower at 3.57%.

The ECB's comments however helped take German Bund futures off the day's lows of 141.14. It saw a settlement close of 142.00, down 12 ticks compared to Friday.

Thin trade exaggerated price moves, and the market was expected to remain vulnerable to speculative headlines. Further concrete details on the ECB plans would be needed before such price moves could be seen as a sustainable trend, market participants said.

"Many in the market would still have doubts about whether the ECB has the capacity to make this work. It would actually require (the ECB) to pledge unlimited purchases which I think does not really fit with their mandate," said Elwin de Groot, senior market economist at Rabobank in Utrecht.

SEPTEMBER

The expectation of mass buying of short-maturity Spanish debt has already halved Spanish 2-year yields since ECB President Mario Draghi said on July 26 the bank would do whatever it takes to preserve the euro.

One week later he indicated the bank may start buying government bonds again but only if countries asked euro zone rescue funds for aid first. Some analysts have taken that to mean that the situation in Spain, for example, would have to deteriorate further before any intervention.

Policymakers remain in the early stages of thrashing out the details of any aid, with a series of critical meetings scheduled in the next few weeks, and Germany's Bundesbank, the central bank of Europe's largest economy, is fiercely opposed to restarting the bond buying programme.

"As much as there might be a risk-on move into September's events, you've got to realise that the Germans can dig their heels in, the Dutch will do the same around election time and the Finnish still have collateral demands - northern Europe is not happy about this," a trader said.

Germany's Bundesbank on Monday stepped up its resistance to a ECB plan to buy billions of euros worth of Spanish and Italian government bonds to reduce those countries' crippling borrowing costs.

The ECB holds its regular policy-setting meeting on Sept. 6 followed by a meeting of euro zone finance ministers on Sept. 15 - both of which were expected to shed some light on plans to help Spain tackle its costly debt burden.

"A lot of the real money guys are out at the moment, I think if they'd been around we'd be seeing a lot more buying on these dips in the Bund... for the time being it's just wait until September," a second trader said.

A break under 141.50 - the Bund's first main support offered by the mid-point of Thursday's and Friday's rally - would be a further negative and suggest a resumption of the bearish trend to the June 29th low of 139.72, UBS technical analysts said.