Money markets safe haven t bill flows immune to periphery rally

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* ECB bond-buying bets spur demand for peripheral T-bills* Demand for German, other top-rated bills not dropping* German, Dutch, French bill yields to stay around zeroBy Marius ZahariaLONDON, Aug 6 Renewed appetite for Italian and Spanish treasury bills on prospects of the ECB stepping in to buy the two countries' debt is unlikely to divert flows away from safe-haven German and French short-term debt markets. Since European Central Bank President Mario Draghi said on July 26 he would do whatever was necessary to preserve the euro, Italian one-year bill yields have halved to 2.27 percent, while their Spanish equivalents have dropped some 200 basis points to 3.07 percent. Last week, Draghi said the ECB may start buying government debt again if troubled countries activated the euro zone's rescue funds and that any forays would target short-dated paper, further strengthening demand for peripheral T-bills. However, this has not prompted a reversal of safe-haven flows into top-rated, short-dated euro zone debt. Short-term German, Dutch, Finnish and French yields have changed little in the past month, hovering at a few basis points either side of zero, meaning in some cases investors are willing to pay to park their cash with a top-rated country for six months or one year.

France and the Netherlands both sold bills on Monday at negative yields. While the ECB is expected to ease Italian and Spanish access to short-term debt markets, its actions are not seen sufficient to assuage investor concerns about the future of the euro zone."Those investors who are buying German T-bills at negative yields are not the kind of investors that would consider buying Italian and Spanish credit," said Christoph Rieger, rate strategist at Commerzbank."At the end of the day, investors will still be very concerned whether the ECB intervention will actually work. If they will only focus on short-term (debt) it will not solve the funding problems that these countries are facing."

Bond traders say investors buying short-term Italian and Spanish debt are mainly domestic banks or hedge funds -- institutions that have a higher tolerance for the risks associated with such assets. BUYING LOCAL Markets for T-bills, which have a maturity of less than two years, have been increasingly driven by domestic investors in the past year, analysts say.

The dormant state of unsecured interbank lending has boosted banks' demand for short-term debt, which can be used at low cost as collateral in secured lending. The ECB's massive liquidity injections have also helped the bill market. Some banks use bills as collateral to get ECB funds while many lenders are simply parking their ECB cash in the T-bill market until they have to use it to pay back maturing debt. As the cost of using a bill as collateral differs depending on its rating, banks in the euro zone's top-rated countries have preferred to buy domestic bills over higher-yielding peripheral paper. Many risk managers at these banks have placed restrictions on peripheral debt holdings as they try to cut exposure to the bloc's most vulnerable debt markets."We have seen a huge decrease in cross-border lending in the past months. Especially in France, banks are not buying into peripheral markets anymore so they are moving into French T-bills," ING rate strategist Alessandro Giansanti said."Many investors just don't want to invest money in low-rated assets, even if it's T-bills."He said that while demand for Spanish and Italian T-bills was likely to increase in the near-term, the appetite for German and other AAA- or AA-rated debt was likely to remain unchanged. He expected the gap between short-dated Spanish and German debt to fall from roughly 300 bps to 150 or even 100 bps in the next few months, while German yields remain around zero.