Italian bond yields soar after poor debt sale

London: Italian bond yields soared on Friday, after borrowing costs rose sharply at a short-term debt auction, raising questions over the eurozone’s future as politicians failed to come up with decisive solutions to the debt crisis.

Belgian bonds were also under pressure ahead of auctions next week, while German Bunds - which had been in positive territory earlier - sold off as markets refocused on the possible costs to Berlin of propping up the eurozone.

Two-year Italian bond yields rocketed half a percentage point to a euro-era high above 8 percent, albeit in low volume.

The surge came despite the European Central Bank buying bonds in the secondary market, raising more questions about the longer-term sustainability of the third biggest euro zone economy’s debt and, by extension, of the currency bloc itself.

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Rome paid a record 6.5 percent to borrow over six months on Friday and almost 8 percent to issue two-year zero coupon bonds .

“The object of the exercise this morning was to get the job done and they’ve done that, but that’s about the only positive thing to say,” said ING rate strategist Padhraic Garvey.

“It’s difficult to (issue paper) at market levels so it is being done at a discount, which is quite different to where we were a number of weeks or months ago when stuff typically came at a premium to market levels.”

The leaders of France and Germany agreed on Thursday to stop bickering about whether the European Central Bank should do more to rescue the euro zone, but had little else to offer.

Germany maintained its opposition to common eurozone bonds and there were no signs of cracks in its resolve to resist pressure for the ECB to take more radical action.

Belgian bond yields were dragged higher, up 7 basis points at 5.827 percent, before bond sales on Monday while the cost of insuring its debt against default hit a record high.

“I think Belgium will be included in the ECB buying programme… I don’t see how they can avoid it now that yields are getting up towards 6 percent,” a trader said.

Italy returns to market next week with an 8 billion euro sale of longer-dated debt, at which it is again expected to have to pay high yields.

December Bund futures were 66 ticks lower at 134.39, remaining under pressure after a failed 10-year bond auction on Wednesday.

“Bunds are really just too cheap at the moment. The market is trading like it expects Armageddon and equities are trading like they expect some sort of muddle-through, but Bunds are usually right,” a second trader said.

“Very few people are doing anything other than the trading they have to do but we’d expect to see tentative buying again around the 2.25 percent level.”

Trading remained thin and choppy with the US bond market open only for a half day.

Ten-year German yields were 6 bps higher at 2.19 percent, testing the upper end of the range in place since August.

“Rallies now look running out of steam sooner than before, given the changing credit perceptions,” Commerzbank strategists said in a note, but added that the potential for higher yields looked limited given a weakening economic backdrop.

The underperformance of Bunds this week has left them yielding almost the same as UK 10-year gilts and around 25 bps more than US Treasuries. RBS said this trend could continue based on what happened during the financial crisis and recessions of 2002 and 2008.

“Outside of the contagion argument, pay attention to the fact that gilts and Treasuries have outperformed Bunds in a recession. A significant slowdown in the global economy now seems near-certain, yet another reason for gilts and Treasuries to continue outperforming,” the bank’s strategists said.

Reuters