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Italian, Greek Bonds Rally as Hunt for Yield Expands

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07/17/2019 | 04:23pm EDT

By Daniel Kruger

Investors are buying bonds from once-avoided European countries, spurred by expectations that ongoing easy-money policies from central banks will continue to fuel demand for debt.

The yield on Italy's 10-year government bond, which falls as bond prices rise, has dropped by more than one percentage point since the end of May, while the yield on Greek 10-year debt has fallen almost as fast. The moves have outpaced recent declines in German and U.S. government bonds, which are perceived as safer.

Investors' hunt for yield has been evident at government debt auctions. Greece sold EUR2.5 billion of seven-year notes Tuesday, attracting more than four times that amount in bids from investors. That compares with an offering in Germany last week, where investors submitted only slightly more bids than the EUR3.15 of negative-yielding 10-year debt for sale.

Some investors have bought the securities because they are unwilling to buy safer bonds at increasingly negative yields, while others have snapped them up because they are part of a diminishing supply of bonds from European governments that still pay investors to hold them. Negative-yielding bonds cost investors more to buy than the combined total of interest and principal payments they receive in return. That means investors are effectively paying borrowers to hold their money.

European Central Bank President Mario Draghi surprised some investors last month when he signaled that the central bank was prepared to lower interest rates further from their current level of negative 0.4% and resume purchasing bonds after halting that policy at the end of last year. Fed Chairman Jerome Powell signaled the Fed will lower rates at its meeting later this month.

"The European situation tends to go in long cycles," said Robert Tipp, chief strategist at PGIM Fixed Income, which owns more Italian and Greek debt than its benchmarks. "Markets have been very enthused" by Mr. Draghi's signals of further support, Mr. Tipp said.

Investors have shifted into the riskier bonds at a time when expectations for interest-rate cuts by the ECB and the Federal Reserve have pushed the yield on German 10-year debt to record lows and the 10-year Treasury yield to multiyear lows.

The yield on the benchmark 10-year Treasury note settled Wednesday at 2.059% down from 2.124% Tuesday. The yield on 10-year Greek debt was 2.218% and the yield on 10-year Italian debt was 1.583%.

Yields on sovereign debt in Germany, France, Holland and several other countries have fallen to record lows below zero. There are about $11.4 trillion of bonds with negative yields, which account for 23% of outstanding debt, according to Bank of America Merrill Lynch.

That search for yield has led investors from overseas to add to their Treasury holdings. Foreign investors increased their stakes in U.S. government debt by 1.6% in May, the most since 2011.

The election of a new government in Greece has supported demand for its debt, according to investors. Italian yields rose earlier in the year as some investors became concerned that the government's plans to run large budget deficits to spur activity in a slow-growing economy could lead the country to exit from the European Union. As officials have scaled back their plans, those worries have largely abated, investors said.

Investors have also bet that International Monetary Fund President Christine Lagarde, announced as the leading candidate to succeed Mr. Draghi when his term ends in October, is likely to maintain policies that support markets. The ECB first set its deposit rate below zero in 2014.

Concerns remain about the Italian and Greek economies, however, leading some investors to stay on the sidelines.

"We missed it" with Italy, said Edward Al-Hussainy, a government debt strategist at Columbia Threadneedle Investments. "We were too cautious on the fundamentals."

While Mr. Al-Hussainy said he expects yields for Italian bonds to continue to fall, the firm doesn't intend to chase potential gains. One reason is that much of the rally has been driven by other investors chasing gains, further fueling the decline in yields.

"The momentum factor is huge," he said.

Write to Daniel Kruger at Daniel.Kruger@wsj.com

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