June 26, 2018 / 8:05 AM / a month ago

Spain bond sale to test euro zone resilience to political risk

* Ten-year sale to test appetite for “peripheral” Europe

* Euro zone yields rise as investors make space

* Merkel to talk to EU leaders amid domestic tensions

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, June 26 (Reuters) - Euro zone government bond yields rose on Tuesday as investors made space for a planned 10-year sale by Spain, a possible test case for the market’s ability to withstand a period of political uncertainty in the bloc.

The syndicated deal by Madrid - a structure where borrowers appoint banks to sell their bonds directly to investors — is expected to be completed on Tuesday.

Two weeks ago, bankers who manage government bond sales told Reuters the deal was unlikely to materialise so soon after the potentially destabilising emergence of an anti-establishment government in Italy.

But on Tuesday, market sentiment towards it appeared to be positive, with yields rising 1-3 basis points across the board, suggesting investors were clearing space in their portfolios.

Germany’s 10-year government bond yield, the benchmark for the region, was up 2 bps at 0.34 percent while Spain’s 10-year bond yield was steady at 1.37 percent.

“The expected size is 7-8 billion euros, and a large order book would be a good signal for Spain, the periphery and the fact that Italian fears are contained to Italy,” said ING strategist Benjamin Schroeder.

In the euro zone debt crisis of 2011-2012, all lower-rated debt from governments on the euro zone periphery sold off on contagion fears when Greece appeared on the brink of default.

But this effect seems to have reduced significantly since. Though Spanish and Portuguese debt did sell off when a coalition of the 5-Star Movement and League was taking office in Rome, it soon recovered.

The spread between Spanish and Italian 10-year bond yields was at 147 bps on Tuesday compared with 47 bps at the start of May. Earlier this month, it hit 165 bps, its widest since January 2012.

“We find Spanish government bonds are sufficiently insulated from market volatility as Spain does not face the same structural and political challenges as Italy,” Mizuho analysts said in a note.

They expect the expect the deal to be at the smaller end of the 8-10 billion euro range of recent 10-year bond sales.

MERKEL WATCH

Investors will also be keeping an eye on the political situation Germany, where Chancellor Angela Merkel continues to seek a Europe-wide solution on migration as she faces a revolt on the issue from her Bavarian coalition allies that threatens her government.

“Do we really think she will get anything out of the EU summit that will satisfy her CSU (Bavarian) partner? Tensions have not been defused and there’s still a risk of government breakup in Germany,” said Schroeder of ING.

This possibility has kept safe-haven German Bunds pinned near recent lows, and though 10-year yields rose 2 bps to 0.34 percent, they were still close to near one-month lows of 0.304 percent hit on Monday.

Reporting by Abhinav Ramnarayan; editing by John Stonestreet

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