Spanish bond yields lag as investors queue up for rare linker

LONDON: Spanish yields lagged a broad rally in euro zone bonds on Tuesday as investors queued up for a rare sale of inflation-linked debt from the country.

Traders said the underperformance was because investors had sold bonds in secondary markets to make room in their portfolios for the new linker, debt soon to be eligible for European Central Bank purchases and inclusion in major bond indices.

Interest in the new deal topped 4 billion euros, Thomson Reuters' news and analysis service IFR reported, and will price later on Tuesday.

While price guidance indicates the bond will offer a real yield of around 0.32 percent, strategists said the breakeven rate -- the difference between this and the yield on nominal bonds -- was still attractive to investors betting that inflation will pick up.

"Over the coming months there certainly will be value in inflation-linked bonds," said Societe Generale strategist Ciaran O'Hagan.

"I've been very surprised that linker bonds have been so cheap. The ECB is coming in to buy them and that was a surprise for some."

Yields on Spain's 10-year bonds were up 1 basis point at 1.27 percent, while most other equivalents in the euro zone were 1-2 basis points lower.

PERFECT TIMING

Analysts said the deal will let Spain lock in ultra-low borrowing costs that have shrunk under the ECB's bond-buying scheme, while tapping demand from investors looking forward to the inclusion of Spanish and Italian bonds in Barclays' inflation-linked indices at the end of the month.

The new bond, which matures in November 2030, is Madrid's third ever linker following five- and 10-year issues last year.

Real yields on inflation-linked bonds have crashed since the ECB announced linkers would be included in its purchase scheme at the start of the year.

The real yield on Spain's 10-year linker is now negative, while Italy's is barely positive.

Italian and Spanish linkers have performed particularly well ahead of joining Barclays' World Government Inflation-Linked (WGILB) and Euro Government Inflation-Linked (EGILB) bond indices on March 31.

"The timing of that bond makes a lot of sense," said Commerzbank analyst Alexander Aldinger.

Investors on linkers also focus on the breakeven rate - which broadly reflects market expectations of where the average inflation rate will be over the life of the bond.

With the ECB forecasting inflation to start rising at the end of this year, reaching its target of just below 2 percent by 2017, analysts say there is still plenty of value in these assets.

But then there is political risk. Spanish bond yields have been under pressure since the Podemos party made big inroads in regional elections in Andalusia on Sunday, showing the anti-austerity sentiment that brought the leftist Syriza party to power in Greece has taken root in Spain.

Greece's 10-year yields dropped 30 bps to 11.23 percent after its government said on Tuesday it will present urgently needed economic reforms to its euro zone partners by next Monday.