Some of the hedge funds that made the biggest and most sophisticated bets against European sovereign debt began reversing those trades last week.
People familiar with the trading at three large hedge funds that specialize in trading bonds and credit default swaps said that those funds began to cover short trades and actually go long European sovereign bonds last week.
"The idea is that it has gone too far, especially with Italy's debt," a trader at one credit fund said.
Italian bonds briefly traded above the 7 percent yield that many consider the "unsustainable" level. An auction of 3 billion euros ($4.1 billion) of five-year Italian bonds reach a yield of 6.3 percent. That's the highest level since June 1997, according to reports. It's nearly a full point higher than just one month ago.
These high yields are attracting some buying from hedge funds that see it as a "win-win scenario."
"If yields keep climbing, the ECB will have to take action to bring them down. If they fall, then I have discounted bonds to sell into the market," said one hedge fund manager.
Yields move in the opposite direction of bond prices, so buying high yield bonds can be a way of betting that yields will fall and prices will rise.
The people at the funds involved asked that each of their funds not be named because their trading strategies are not public and they are barred by the Securities and Exchange Commission from making public comments that can be interpreted as publicly soliciting investors.
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