Italian and Spanish yields rise above 6pc on political impasse

LONDON: Italian and Spanish bond yields rose above 6 percent on Monday as investors feared a euro zone meeting on Thursday would make little progress towards a second Greek bailout and a solution to the regional debt crisis.

As Germany presses for significant private sector involvement and the European Central Bank insists it will not accept defaulted bonds as collateral, Greece seems once again to be in a bind.

Any private sector involvement would likely result in a ratings downgrade to default. If the ECB sticks to its guns, Greek banks could be shut out of commercial markets.

The rapid rise of Italian and Spanish bond yields are making a solution even more pressing as it becomes increasingly expensive for bigger euro zone economies to finance themselves in commercial markets.

"Despite the rising contagion we saw last week in Italy and to a lesser extent Spain, the EU does not seem to be closer to any sort of agreement in 1) providing a second bailout for Greece and 2) related to how much private sector involvement is going to be in that package," Nick Stamenkovic, a fixed income strategist at RIA Capital Markets said.

"Thursday's meeting might be a disappointment, and any substantial decision on Greece will not be in place until September."

Yields on Italian 10-year paper rallied 25.6 basis points to 6.03 percent and those on Spanish 10-year bonds gained 26 basis points to a euro life-time high of 6.35 percent.

The yields were nearing 7 percent -- a level beyond which funding costs are perceived to be unsustainable.

Markit data showed the cost of insuring Italian debt against default rose 15 basis points to 323 basis points and that of Spanish debt increased 19 bps to 369 basis points.

German Bund futures rallied 52 ticks to 129.51.

The rising cost of funding for Italy and Spain was piling the pressure on euro zone policymakers to come up with a plan as investors focussed on Thursday's meeting.

"The lack of political response is really leaving the market with no other choice but to continue to disintegrate," said a London trader.

German Chancellor Angela Merkel called on Sunday for private investors to make a major contribution to bailing out Greece. European Central Bank Executive Board member Lorenzo Bini Smaghi meanwhile suggested the EFSF, Europe's bailout fund, be allowed to provide funds for a buy-back of bonds from the market. .

Across the Atlantic, the situation was just as worrisome. Republicans and Democrats have yet to agree on a plan to cut the nation's deficit and raise its debt limit in time to avoid an unprecedented US default.

"There are two (major) regions in the world -- the United States and the euro area -- where we have debt problems climaxing in the coming days," said Kornelius Purps, fixed income strategist at UniCredit.

Analysts expected an "eleventh hour" solution to the US stalemate, although many analysts say that it would not amount to a sustainable long-term plan for debt reduction.

The cost of insuring US debt against default fell 3 basis points to 53 basis points after edging one basis point higher on Friday.

The spread between 10-year German bond yields and US Treasury yields widened to around 24 basis points, with German bonds outperforming their US equivalent.

Ten-year German bonds currently yielded 2.64 percent, less than their US counterparts at 2.88 percent.

Failure to increase the debt ceiling by Aug. 2, when the US government will run out of money to pay its bills, could send shockwaves through global financial markets.

Copyright Reuters, 2011