Italian, Spanish, Portuguese Bonds Slump

By Garth Theunissen and Emma Charlton - Jul 11, 2011 1:28 PM GMT+0300

Italian and Spanish bonds tumbled and German bund yields sank to a seven-month low as contagion from Greece’s debt crisis threatened to spread to bigger economies, stoking demand for the safest assets.

The spreads investors demand to hold Italian, Portuguese and Spanish debt over bunds widened to euro-era records. The European Central Bank is seeking to double a fund to 1.5 trillion euros ($2.14 trillion) to cover an Italian crisis, Die Welt reported yesterday, citing senior central bankers. EU leaders are prepared to accept a Greek default on some obligations, the Financial Times said yesterday.

“There’s pronounced risk-off sentiment,” said Michael Leister, a fixed-income analyst at WestLB AG in London. “You can clearly see the market is worried. We are seeing a self- fulfilling prophecy, where yields increase due to contagion and then the market gets worried about the high funding costs, as do the rating agencies.”

Yields on 10-year Italian bonds increased for a sixth day, climbing 13 basis points to 5.40 percent at 10:45 a.m. in London after surging as much as 21 basis points on July 8. The spread over German bunds widened to 268 basis points. Spanish 10-year yields climbed 13 basis points to 5.81 percent, expanding the spread over German debt to as high as 307 basis points.

Record Spread

Portugal’s 10-year yield climbed 43 basis points to 13.36 percent, sending the spread over German bunds to as much as 1,065 basis points.

Ten-year bund yields were eight basis points lower at 2.75 percent, the least since the beginning of December last year, as investors sought the safest assets. Two-year German note yields dropped four basis points to 1.41 percent.

European stocks fell for a second day, the euro sank to a two-week low against the dollar and 10-year Treasuries yielded the least this month as investors favored the safest assets. European officials remain at loggerheads over the best way to solve the 17-member bloc’s debt crisis and prevent Greece from undergoing a disorderly default.

“Contagion risk is increasing rapidly,” said Orlando Green, a fixed-income strategist at Credit Agricole SA in London. “The market’s concern is that if Europe can’t display unity on Greece, then how is it going to manage to deal with Italy, which has a much larger debt burden? The current rescue package is nowhere near big enough to cover an economy the size of Italy.”

Default Swaps

Credit-default swaps protecting Italian bonds rose 28.5 basis points to an all-time high of 279.5, while contracts on Greece climbed 102 basis points to 2,275, Ireland increased 52 basis points to 972 and Portugal surged 40 basis points to 1,080, also records, CMA prices show.

Two-year Italian yields rose to a two-and-a-half year high as the nation’s financial-market regulator moved to curb short selling after the benchmark FTSE MIB index plunged 3.5 percent on July 8. The slide was led by UniCredit SpA and other bank shares, which are among the largest holders of Italy’s debt.

The gap between Spanish and Italian 10-year bond yields narrowed to 40 basis points, the least since Nov. 16. The spread was 49 basis points a week ago, according to data compiled by Bloomberg.

The ECB is seeking advice from banks on what to do in the event of a sovereign default in the euro area, Handelsblatt reported, without saying where it got the information. The newspaper said the ECB has written to “more than five” financial institutions in recent days, requesting that they apply to act as advisers.

Italian Bond Market

European Union President Herman van Rompuy and European Commission President Jose Manuel Barroso are scheduled to meet today with European Central Bank PresidentJean-Claude Trichet, Luxembourg Prime Minister Jean-Claude Juncker and European Economic Commissioner Olli Rehn ahead of a meeting of euro-area finance ministers in Brussels today.

Italy is the euro region’s biggest bond market, with 1.8 trillion euros of outstanding debt as of Dec. 31, compared with 1.1 trillion euros of German debt outstanding on March 31, according to websites from the nations’ debt agencies.

The Mediterranean country plans to sell securities maturing in 2016, 2017, 2023 and 2026 on July 14. It hasn’t said how much it plans to sell. Greece will auction 1.25 billion euros of 26- week Treasury bills on July 12.

A report today showed French industrial production increased for the first time in three months in May. Output at French factories, mines and utilities increased 2 percent from April, when it fell a revised 0.5 percent, the Paris-based statistics office said today. Economists had forecast a 0.5 percent increase, according to the median of 12 estimates in a Bloomberg survey.

To contact the reporters on this story: Garth Theunissen in London atgtheunissen@bloomberg.net;