'Flight to yield' boosts demand for Italy's government bonds

Italy's 10-year bond yield fell to its lowest level since mid-October on Wednesday, as appetite in world markets improved and easing concern about Italian political risks kept investors interested in the bloc's higher-yielding bond markets. Having fallen sharply in recent sessions, yields on safe-haven German Bund yields were a touch higher at -0.36% - off three-month lows hit on Tuesday.

Fears about the economic impact of the coronavirus outbreak in China have boosted demand for fixed income in the past week. Peripheral government bonds, which often trade in line with other riskier assets, however, have outperformed even on days when stocks have sold off.

Commerzbank analysts say "flight-to-yield" is dominating over "flight-to-quality" - a phrase that describes the rush to top-rated, safe assets at times of uncertainty. With more than half of the eurozone government bond market in negative yield territory, selloffs or auctions tend to be viewed as an opportunity to buy bonds offering any yield.

Greece on Tuesday attracted record orders for a 15-year bond sale. France also received a strong demand for a 30-year bond sold via a syndicate of banks on Tuesday, with demand reaching 38 billion euros ($42.16 billion) for the 5 billion euro offer. French 30-year bond yields are at 0.69%

A ratings upgrade for Greece on Friday and the failure of Italy's right-wing League to win a key regional election at the weekend, bringing relief to an embattled government, have also boosted sentiment towards southern European bonds. "The negative yields backdrop and the view that this will stay for a while means the traditional investor base is having second thoughts about staying in the German bond market," said Rainer Guntermann, a rates strategist at Commerzbank.

"In the periphery, there are some country-specific factors - the weekend election in Italy, the credit ratings upgrade in Greece." Italy's 10-year bond yield fell 3 basis points to 0.994%, its lowest level since mid-October. The closely-watched gap between Italian and German Bund yields narrowed to around 134 bps - its tightest since September.

Analysts at Mizuho said they believed the spread had room to tighten further, adding that 30-year Italian bond yields could fall to 1.5% from current levels around 2%. Trade across eurozone bond markets was expected to be generally subdued ahead of a U.S. Federal Reserve rate decision later in the day.

The Fed is widely expected to keep rates on hold but officials are likely to discuss possible changes to how they manage the U.S. central bank's key overnight borrowing rate. ($1 = 0.9014 euros)

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