LONDON: Italian government bond yields slid to multi-month lows and Spanish yields fell after the European Central Bank's second offering of cheap three-year funds but some traders said the debt was becoming vulnerable to profit-taking.
Banks grabbed 530 billion euros at the ECB offering of cheap three-year funds on Wednesday in a move investors hope will further ease tension in the banking sector.
The extra cash in the system should also facilitate Italy and Spain's access to market funding, but some in the market said those countries' bonds were looking expensive, having risen sharply after the first ECB loan offering in December.
"A lot of good news is already in the price, (that) would be my concern. But certainly flows-wise rather than expectations-wise these funds are likely to lend support to the front end of the peripheral curves," Richard McGuire, senior fixed income strategist at Rabobank said.
But he added that fundamentals could come back into play without the prospect of a third round of ECB funding.
"We are positioned for a risk-off (environment) albeit in a cautious way, favouring core flatteners," he said, referring to a bet that yields on longer-dated bonds in core euro zone countries would fall as those on shorter-dated debt had done.
Italian two-year debt yields fell to 2.27 percent , their lowest since late 2010, while 10-year yields eased to their lowest since September at 5.26 percent . Two-year yields dropped 17 bps to 2.32 percent.
Spanish two-year yields fell 12 bps to 2.44 percent, while the 10-year equivalent was 5.3 bps lower at 5.00 percent.
"The two-year and three-year part of the curve is super rich because of the LTRO (long-term refinancing operation) bid," a trader said, referring to the Italian and Spanish curves.
"After today, our guess is that it should start seeing profit taking on this part of the curve or people putting on flatteners. So selling 2s and 3s and buying 5s and 10s."
Bucking the trend, Portuguese 10-year government yields surged 65 bps to 13.91 percent. "Portugal is a country that will not really benefit from the LTRO and volumes are low there and it doesn't take much to move the prices," a second trader said.
NEW RECORD
ECB liquidity helped German Bund futures to a new record high of 140.28, up 22 ticks on the day. It last stood up three ticks on the day at 140.09.
"The market is reacting pretty well, everything is going up, I think the market is starting to discount a Japanese style scenario where rates stay low across the curve," a third trader said. "Everything gets distorted when you have too much money in the system, valuations become very difficult."
A German sale of 10-year bonds met decent demand even though it coincided with the announcement of the LTRO take-up.
Germany sold 3.26 billion euros of the paper at an average yield of 1.83 percent, just above the 1.82 percent seen in a sale on Feb. 1, and drew bids for 1.4 times the amount on offer, the same as at the previous auction.
"The auction went reasonably well given the very tricky environment right after the tender and it was basically a mirror image of the last Bund auction," said Michael Leister, a rate strategist at DZ Bank.
Ten-year German government bond yields were down slightly at 1.79 percent.
Analysts said the underlying bid for German bonds was based on the view that the ECB cash buys the euro zone time to gets its fiscal house in order but does not solve its debt problems.
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