Lower-rated euro zone bonds clawed back some losses on Friday after one of the sharpest sell-offs since the height of the 2012 euro crisis, with the possibility of further European Central Bank stimulus seen as a barrier against a steeper rise in yields. Nevertheless, markets remained nervous as global growth worries persist.
Deflation hit five euro zone countries in September, including Italy and Spain, while a string of surprisingly weak German economic data and a deteriorating rating outlook for France has had investors wondering where growth will come from. Greek yields remained on track for their biggest weekly rise since 2012 and Portuguese bonds were on course for their worst week since 2013. Spanish and Italian bonds also sold off heavily this week, although they remained much closer to their record lows than their 2012 peaks.
"The adjustment yesterday was pretty marked and I don't think there's a case for that to continue in the same way," said Chris Scicluna, the head of economic research at Daiwa Capital Markets. Spanish, Italian and Portuguese 10-year yields were 5-19 basis points lower on the day at 2.17 percent, 2.49 percent, and 3.31 percent respectively, after starting the session higher.
The gap against German government bonds narrowed as the 10-year yield for the euro zone benchmark rose by 4 basis points to 0.86 percent. ECB policymakers speaking on Friday did not show any urge to ease monetary policy further, but kept their options open. Governing Council member Ewald Nowotny said the central bank had room for more action, but the euro zone economy did not need emergency measures. "The main reason you buy periphery is that you believe that at some point Draghi will do QE," said Michel Danechi, portfolio manager at EI Sturdza's strategic emerging Europe fund. "The weakening in Germany and elsewhere must have increased the chances of QE."
Greek bonds led the rebound after leading the sell-off. Ten-year yields were down 88 basis points to 8.07 percent, following their biggest two-day rise since mid-2012 with the biggest one-day fall since the same period. They have jumped more than 200 bps in the past week as investors took additional risks into account, such as the likelihood of early elections next year - and potentially a radical shift to the far left.
The Greek prime minister on Friday dismissed the chance of a snap election next year, saying that elections would be held at the end of the four-year parliamentary term in 2016. He also reiterated the government's plan to exit its international funding programme a year early, mooted at the start of the week and another reason cited for the sharp sell- off. Greece was talking to lenders about a potential credit line post-bailout, he said. The rise in yields could give the government pause, though. "With bond yields at 9 percent, an exit strategy is just not possible. When they can raise money at 4-5 percent, they can talk of exiting the IMF programme, but now it's not realistic," said Danechi, whose fund owns Greek bonds.
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