European bonds rallying sharply again

For the 2nd day, European bonds are rallying sharply, particularly on the short end. Spanish and Italian 2 yr yields are each down by about 50 bps for the 2nd straight day. The Spanish 2 yr yield in particular is at the lowest since Apr and has been cut in half since late Nov. The French 2 yr yield is falling to the lowest since Sept ’10. I can’t explain the sudden enthusiasm for this paper. Some say that banks are the big buyers, tapping 1% ECB 3 yr funds and playing the carry trade by buying higher yielding sovereign debt but I can’t imagine this is going on after banks spent the last few months selling sovereign debt knowing the markets view it as toxic. Now they’re going to load up again? I just don’t see it. The euro basis swap is narrowing by 19 bps to 121 to the cheapest since last Thurs. After 6 straight days of losses, the Shanghai index bounced 2% but the Indian Sensex index fell to the lowest since Nov ’09. The Reserve Bank of India ended its rate hiking but gave no indication that cuts will soon follow with inflation remaining too high. Unlike the Western world seeing credit downgrades or the possibility of them, Fitch raised Indonesia’s credit rating to investment grade last night and S&P today put Philippines BB rating on credit watch positive from stable. Both have 5 yr CDS trading cheaper than France.

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