Spanish bond yields rise ahead of key snap election outcome

Spanish government bonds lagged the eurozone core on Friday before an expected announcement of early elections, with analysts saying any political impact on sentiment would be short-lived given the country's decent macro-economic outlook. Prime Minister Pedro Sanchez is expected to call a snap national election after parliament rejected his 2019 budget. He is due to address the media at 0900 GMT.

Morgan Stanley analysts said that, while the chances of fiscal slippage in Spain looked bigger than previously, its economic outlook still appeared solid, and they remained bullish on the country's bonds in the medium term. "The macro fundamentals remain robust in absolute terms and relative to the semi-core – a view which we don't think is yet fully priced in by the market," wrote rates strategist Robert Brown.

He said a dovish ECB outlook would provide broad support for the periphery's debt this year as investors reach for yield and the ECB seeks to contain volatility. Spanish 10-year government bond yields were at 1.269 per cent, up around 2.5 basis points on the day.

Italian yields were also higher while core euro zone debt was little changed. "The elections could be a source of short-term volatility but I can't see how it will change the bigger picture," said Jan von Gerich, rates strategist at Nordea.

Markets are also digesting a mixed U.S. economic picture in the U.S. and what it means for Federal Reserve policy. Core euro zone bond yields fell sharply on Thursday after weak U.S. retail sales data added to the case for a lower-for-longer rates outlook.

Yields held close to these levels on Friday after U.S. President Donald Trump agreed to sign a government funding bill which has prevented another shutdown, but said he would declare a national emergency in an attempt to fund his U.S.-Mexico border wall. Trade talks with China remain ongoing. German 10-year government bond yields held below 0.1 per cent in early trade while other 10-year core yields were largely flat on the day.

Nordea's Gerich said that despite the weak retail sales data, the market should acknowledge that "economic damage to the U.S. has been more limited than elsewhere," while noting that at current low levels, bond yields did not have much room to fall further. "For that pricing to materialise we would need to see more material weakness in (the) U.S."