Italian, Spanish Bonds Slump on Concern European Aid May Not Be Sufficient

Italian and Spanish government bonds slumped, increasing the yield relative to benchmark German bunds, on speculation Europe’s aid package may not be sufficient to prevent contagion.
German bonds rose for a fourth day and European bank stocks slid as Finance Minister Wolfgang Schaeuble said the government is against a “blank check” for the European Financial Stability Facility to buy bonds of troubled euro members in the secondary market. The yield on bunds fell to a one-week low as U.S. lawmakers struggled to reach an agreement over the nation’s debt ceiling, boosting demand for the safest European assets.
“If you look into the details of the EU summit decision, it doesn’t take you long to get to where the weak points are,” said Marius Daheim, a senior fixed-income strategist at Bayerische Landesbank in Munich. “You still have two countries that are too big to save and are not effectively protected from negative market sentiment. The U.S. debt crisis is also a factor that supports German bunds.”
Italian 10-year bonds yields rose 13 basis points to 5.76 percent as of 12:30 p.m. in London. The 4.75 percent security due September 2021 fell 0.945, or 9.45 euros per 1,000-euro ($1,449) face amount, to 92.92. Equivalent-maturity Spanish yields were eight basis points higher at 6.04 percent.

Wider Spreads

Ten-year bund yields fell five basis points to 2.69 percent, the lowest since July 20. Yields on two-year notes declined three basis points, to 1.30 percent.
Italy’s bonds stayed lower after an auction of 942 million euros of inflation-linked bonds due in 2021. Investors bid for 1.69 times the amount of securities on offer, at an average yield of 4.07 percent, compared with a bid-to cover ratio of 1.51 and an average yield on 2.51 percent last time the securities were sold in May.
The difference in yield between Italian and Spanish bonds and their German counterparts widened. The Italian 10-year security yielded 307 basis points more than similar-maturity bunds, up from 289 basis points yesterday, while the Spanish- German spread rose to 334 basis points from 322.
The cost of insuring against default on Italian government debt rose nine basis points to 284 and Spain increased 11 to 334, according to CMA prices for credit- default swaps.

EFSF Mandate

European leaders declined to increase the size of the 440- billion-euro European Financial Stability Facility as part of the array of additional measures to fight the debt crisis unveiled on last week. The EFSF would have about 323 billion euros to fend off any speculative attacks against Spain and Italy after contributing to Greece’s second aid package, European officials said at the time.
“The mandate of the EFSF has been extended but the size hasn’t been increased accordingly,” said Daheim. “You get the impression that there are too many things the EFSF is supposed to be doing. The weak points justify spreads between Spain and Italy and bunds not having narrowed more since the summit.”
In a letter to coalition lawmakers summarizing the results of the July 21 summit, Schaeuble said that “in the future such purchases must only take place under very tight conditions, when the ECB establishes that there are extraordinary circumstances in financial markets and dangers to financial stability.”
His comments echo Chancellor Angela Merkel, who said one day after the summit that she’s opposed to allowing the fund to engage in “unconditioned” bond-buying in the secondary market.

Bank Stocks

France, Europe’s second largest economy, may not hold a parliamentary vote on the new package of financial support for Greece until October, Finance Minister Francois Baroi said.
The French cabinet will clear the plan next week and the nation’s lawmakers will vote by October, he said today.
The risk of bank writedowns and more contagion from the debt crisis helped to drag the Stoxx 600 Banks Index down 1.8 percent, led by Italian lenders. UniCredit SpA slid 3.9 percent while Intesa Sanpaolo SpA dropped 4.2 percent.
Cyprus’s bonds fell after the Mediterranean island was downgraded by to Baa1 from A2 by Moody’s Investors Service, with a negative outlook. The yield on the nation’s 6 percent bond maturing in June 2021 climbed 13 basis points to 10.04 percent.
Two year Irish and Portuguese notes surged, with the rate on Ireland’s two-year debt plunging 103 basis points to 15.22 percent. Portuguese note yields dropped 51 basis points to 14.57 percent.
“People are focusing on the fact that the lending rate is going to be lowered quite substantially” for Ireland and Portugal, said Huw Worthington, a fixed-income strategist at Barclays Capital in London. “We view these two countries as having much more sustainable debt loads than Greece.”
German government bonds handed investors 1.8 percent this year, compared with 3.5 percent for U.S. Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Greek bonds have lost 9.6 percent, while Portugal’s have declined 23 percent, the indexes show.

By Lucy Meakin and Paul Dobson taken from http://www.bloomberg.com/news/2011-07-27/german-bonds-advance-as-u-s-lawmakers-fail-to-resolve-debt-limit-deadlock.html