LONDON: Two-year Greek bond yields fell on Wednesday after the government won a confidence vote, but the broader periphery came under pressure and German Bunds rallied with a debt restructuring still seen as inevitable.
Markets had priced in a successful passage of the vote but the respite for the euro zone's highly indebted issuers was short-lived and yield spreads over German debt widened.
Prime Minister George Papandreou still has to push through key fiscal reforms next week in order to secure the 12 billion euro lifeline readied by international lenders to save Greece from near-term default.
"It's not over," a trader said.
"The question is what happens if, arguably when, they miss their targets later in the year. Contagion is a very quick growing animal." Athens also has to implement the reforms, while policymakers have yet to finalise a second rescue package.
Talks between governments and private creditors about voluntary participation in another bailout will begin across the euro zone on Wednesday but ratings agencies have warned changes to the terms of existing bonds could be considered as a default.
"The Greek vote is clearly a positive, but we've only cleared one hurdle of many," said Rabobank rate strategist Richard McGuire.
"There is still the near-term risk that policymakers may not be able to agree the issue of 'bail ins" for sector involvement in any debt restructuring."
Greek two-year government bond yields were more than 40 basis points lower at 28.08 percent but five-year yields were 40 bps higher.
The cost of insuring against a default also rose, up 67 basis points at 1,900 bps with Reuters calculations based on Markit CDS prices showing the probability of default based on a 40 percent recovery rate at still above 80 percent.
Yields on the euro zone's other highly indebted issuers were mostly mixed. Spanish and Italian bond yields were 2-5 basis points higher but those on Portuguese and Irish five- and 10-year yields were up to 50 basis points higher. Indeed, Portuguese 10-year yields have risen almost two percentage points during June.
"Portugal has fallen between the cracks a bit, with the Greek bailout battle and worries Spain will also succumb," McGuire said.
"But this is restructuring contagion, the consideration of a Greek restructuring raises fears others will follow, just as they did after Greece was the first to be bailed out."
That, coupled with the still many unanswered questions over Greece, means safe-haven debt is expected to remain well supported for now.September Bund futures were 33 ticks higher at 126.22. Two-year German yields were down 4 bps at 1.498 percent, with 10-year yields down 3 bps at 2.953 percent, having earlier tested 3.0 percent.
"The Bund has come off channel resistance at around the 3 percent level and peripherals are widening," said a trader.
"There's a bit of profit taking after the vote, it was a fast move yesterday and the result came as anticipated."
The confidence vote also took some of the shine off a 3.4 billion euro auction of 10-year Bunds, the euro zone benchmark, although the sale still went smoothly.
"We have a lot of key steps to come like the vote of the austerity package and the solution for the second bailout for Greece," said UniCredit rate strategist Chiara Cremonesi.
"The 10-year area in the context of tightening (ECB) monetary policy is more interesting than the two year. That explains why results are better than the Schatz auction last week."
With the first Greek hurdle cleared, the result of the US Federal Reserve's policy meeting and comments from Chairman Ben Bernanke will draw attention later in the day, with the central bank likely to acknowledge renewed weakness in the US economy.
"In a world without the Greek situation, the focus would be on the question of the strength of the economic recovery, but again, it's already somewhat in the price," the first trader said.
Copyright Reuters, 2011
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