LONDON: Spanish and Italian yields dropped on Tuesday, with traders saying domestic investors were picking up bonds after they cheapened due to political uncertainty ahead of forthcoming elections.
Analysts warned the 4-5 basis point moves had occurred in thin trade as caution before a Federal Reserve meeting kept many investors on the sidelines. Markets see a one-in-four chance the US central bank will deliver its first rate hike in a decade.
Worries secessionists could win an election in Catalonia on Sept. 27 have weighed on Spanish bonds, helping push 10-year yields some 25 basis points higher in the past six weeks. Catalonia accounts for a fifth of the Spanish economy.
Portugal holds elections on Oct. 4 and opinion polls indicate a hung parliament.
Spanish 10-year yields fell to 2.07 percent, while Portuguese yields were 2.63 percent. "Domestics (investors) might be coming in at these levels that they see as attractive. A few people are thinking they cheapened up on the back of political uncertainty," said Lyn Graham-Taylor, rate strategist at Rabobank.
The predominant view in the market is that opportunistic trades from a limited number of investors are moving the two markets more than they would under normal trading volumes.
Monday's 342,085 lots traded in the Bund future, often used as a proxy for volumes in the bond market, were about half this year's average of 647,000. By mid-day on Tuesday, about 172,000 lots had changed hands.
"Spain and Portugal have seen significant underperformance due to election risks so it's not too surprising to see one or two investors looking to add to exposure," said Christian Lenk, rate strategist at DZ Bank. "But I don't see too much change from a fundamental perspective.
The market is focusing on the (Fed) meeting." FED WATCH Domestic growth in the United States may support the case for a rate rise, but market turmoil in China and dwindling expectations for inflation have kept US policymakers cautious.
Fed funds futures put the chance of a hike on Thursday at about 25 percent.
In Japan, the central bank said that slowing emerging market demand was putting further strains on the economy but held off on expanding stimulus, preserving its limited policy options in case a US rate hike sparks more global volatility.
"Even if the Fed decides to initiate the hiking cycle in coming days or months, it will find it hard to sustain the path given the widespread signs of global disinflation which we believe argue for further global monetary easing not less," said Salman Ahmed, chief strategist at Lombard Odier.
Ten-year German Bund yields, the benchmark for euro zone borrowing costs, were up slightly at 0.67 percent.
A slide in German investor morale, as measured by the ZEW index, had little impact on the market.
US retail sales and industrial output data are also unlikely to be decisive for the Fed decision on Thursday, at the end of a two-day meeting.
Greek yields remain near the lowest levels seen this year before an election that is likely to prove inconclusive.
Its two dominant politicians, leftist Syriza leader Alexis Tsipras and his conservative rival Vangelis Meimarakis, ruled out working with each other in a coalition.
A Greek opinion poll showed support for Syriza and the conservative New Democracy at 31.6 percent each.
Ten-year Greek bond yields dipped 4 bps to 8.80 percent.
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