LONDON: Spain's government bond yields fell sharply but remained above the 7 percent danger level on Tuesday, as a short-term debt sale showed Madrid was still able to access international markets although at increasing cost to the Treasury.
The Spanish government paid the highest average cost since the launch of the euro to sell 12-month paper, with the higher yields helping lure investors.
Concerns about the country's long-term ability to fund itself are so acute that analysts were relieved just to see that the short-term paper got away, even if at heavy cost to the Treasury, analysts said.
"The first thing (the market) looks at is whether (Spain) can fund (itself)," Achilleas Georgolopoulos, strategist at Lloyds, said.
"It's going to be the same for Thursday when we have the auction. If they don't raise the full amount there, there's trouble."
Spain faces a tougher test on Thursday when is due to sell up to 2 billion euros of two-, three- and five-year bonds.
Some analysts expect demand to be decent given the small amount on offer and given that domestic investors are likely to step in. Primary market dealers will be obliged to absorb Spain's new issuance but may demand a high price.
The sharp rise in borrowing costs underscores the difficulties the country is having accessing commercial markets after an offer for a bank bailout failed to ease investor concerns about Spain's finances.
With Spanish yields already trading above 7 percent - levels beyond which Greece, Portugal and Ireland were shut out of commercial markets - speculation is rife that the country will eventually be forced to seek full-blown international aid.
Spanish 10-year yields shot above 7 percent on Monday to their highest levels in euro-era history. On Tuesday they were last 15 basis points lower on the day at 7.04 percent.
Italian 10-year yields, which have shown a strong correlation with their Spanish equivalent in recent months, were down 15 bps at 5.9 percent.
"Spain can carry on for a short period of time, maybe two or three months as they can issue at the short end of the curve where funding costs are still more in line with historic levels," said Michael Leister, DZ Bank rate strategist.
"But given how much is at stake and pressure from the Troika ... we think they could take the decision somewhat quicker than we saw with Greece, Ireland or Portugal who tried to stretch it to the limit."
BUND SELL-OFF
German government Bund futures came under another bout of heavy selling, with world stocks gaining on hopes of more central bank stimulus.
The Federal Reserve begins a two-day policy meeting in which it is expected to indicate whether it will launch a new bond purchase programme.
German Bund futures fell 128 ticks to a settlement close of 141.36. One trader said German Bunds were also struggling because of a relative trade.
"There has been a very big seller of Bunds versus Treasuries out of the US, real money (accounts)," he said.
The gap between 10-year Bunds and higher-yielding US Treasuries narrowed to 9 bps from 17 bps late on Monday.
The trader also said that tentative signs that European officials were warming to the idea of reviewing the Greek bailout terms also gave riskier peripheral assets respite at the expense of Bunds.
Greece and its international lenders will renegotiate the programme on which its second financial bailout is based because circumstances have changed, a senior euro zone official said on Tuesday.
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