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LONDON: Italian government bonds trimmed gains on Tuesday with yields rising slightly from near three-year lows as talks to form a new government risked failure, prompting traders to move to the sidelines.

Talks between Italy's ruling 5-Star Movement and the opposition Democratic Party (PD) to form a coalition government ran into trouble as the parties traded accusations over key jobs, including that of interior minister.

Italian bonds had led a rally in European government bonds as hopes of a new government buoyed investor sentiment and appetite for risky assets recovering slightly after US President Donald Trump predicted a trade deal with China after positive gestures by Beijing.

"Investors have become bullish on Italian bonds thanks to the weekend news but a failure to form a government would lead to a significant reversal and cause spreads to widen over core debt," said Daniel Lenz, a rates strategist at DZ Bank in Frankfurt.

Yields on benchmark 10-year Italian debt edged higher to 1.25% from near three-year lows of 1.19% hit earlier. The slight bounce in yields caused spreads between Italian debt and comparative German debt to widen slightly to 191 bps.

Despite Italian political news, bond yields in Italy have mirrored their global counterparts as a rush to perceived safe-haven assets among growing concerns of a trade conflict between the United States and China have pushed yields lower.

So far this year, Italian yields have dropped more than 150 bps to 1.25% from 2.90% at the start of the year.

President Sergio Mattarella has given 5-Star a chance to avert a snap election by forming a new coalition with the PD. Last week he told them to report back by Tuesday, but on Monday he extended the deadline to Wednesday.

 

Core European government bond yields steadied with 10-year German bond yields holding firm at -0.68 bps, not far from a record low of -0.73 bps hit earlier this month.

Although yields on 10-year US Treasury debt were a shade lower at 1.52%, they held firmly above overnight lows of 1.44%.

Global trade tensions have stoked concern about the growth outlook this year, pushing bond yields in the euro area deep into negative territory as investors bet on central bank action to shore up growth and inflation.

Investors have ramped up bets of more policy easing from the European Central Bank with money markets expecting about 13 bps in interest rate cuts at its next policy meeting in September.

Copyright Reuters, 2019