Short-dated Spanish and Italian bond prices rose on Friday with some traders wary of being caught on the wrong side of any fresh moves by policymakers to resolve the debt crisis once the European holiday season ends. German Chancellor Angela Merkel voiced support for the European Central Bank's crisis-fighting strategy, reinforcing expectations of ECB intervention even though any bond-buying would be dependent on Spain and Italy asking euro zone rescue funds for help first.
Traders and strategists said a shortage of Spanish bonds in the repo market - where banks use them as collateral for loans - was also prompting some buying in the cash market by investors who need them to cover short positions. "The fear is that if you go short Spain or Italy you could run into problems with the ECB in a couple of weeks' time," said David Keeble, global head of fixed income strategy at Credit Agricole.
Spanish two-year yields fell 26 basis points to 3.67 percent, while the five-year equivalent was at 5.4 percent, down 22 bps. Ten-year yields fell 9 basis points to 6.5 percent. Shorter-dated Spanish and Italian yields were expected to keep drifting lower as September nears, when the ECB is expected to give more details of its planned measures at its next policy meeting.
RBS strategists said they were targeting Spanish two-year yields to fall to 2.20 percent in coming months, predicting the debt would continue outperforming Italian counterparts on the view that Spain would receive ECB support before Italy. Italian shorter-dated bond yields also fell, with two-year yields dropping 16 bps to 3.13 percent and five-year debt yielding 4.78 percent, 7 bps lower.
"There was some international buying but it's more tactical as people think there's going to be a squeeze when the ECB announces its measures in September but people don't have very strong positions ... There's little flow going through, a lot people are still on holiday," a trader said. The ECB holds its next policy meeting on September 6 when it is expected to give more detail on its planned measures.
Riskier assets got a fillip on Friday on upbeat US economic data and after Merkel backed ECB President Mario Draghi's intervention plans, underscoring attempts by policymakers to show a united front. But mixed messages from Finland and comments from Austria's foreign minister implying Greece should be kicked out of the euro zone underlined the political challenges the region still faces.
Ten-year German government bond yields were down 3 basis points at 1.49 percent although technical charts suggested the recent grind higher had a bit further to run, analysts said. "With this 1.50 percent taken out, I wouldn't be surprised to see 10-year Bund yields edging a bit higher towards 1.60-65, not necessarily today but that would be an intermediate target for next week," Rainer Guntermann, strategist at Commerzbank said.
Credit Suisse technical analysts saw an immediate bearish bias for German debt towards 1.63 percent in the yield and expected fresh buyers only at 1.69-1.70 percent, the upper bound of its trading range since May. Bunds reversed earlier losses to settle up 36 ticks on the day at 142.12.