LONDON: Italian and Spanish bond yields soared on Monday, prompting the European Central Bank to buy the debt, as residual euphoria over Europe's plan to contain its debt crisis cooled with many details of the package still unclear.
Safe-haven German government bonds rose from the market open and peripheral bonds came under pressure before a Belgian debt sale. Five-year Italian yields neared euro-era highs and the 2/10 year Italian yield curve flattened around 10 basis points to the least in a month.
With Spanish bonds also under pressure, the ECB stepped into the market to buy debt issued by the two countries, briefly pushing two-year Italian yields down by around 15 basis points before they returned to near their highest levels since the central bank began buying the paper in September.
"The worrying sign is the front-end of the curves coming under pressure as they price in the increasing risk of a credit event. That is very much what we see for the southern European non-bailout countries this morning," Rabobank rate strategist Richard McGuire said.
"Clearly last week's summit has only had a transitory impact."
Bund futures were more than a full point higher but set to trade within recent ranges this week with 10-year yields capped below 2.30 percent.
Investors are primed for this week's Group of 20 leaders' summit to disappoint, expecting few further details on implementation of Europe's plan to expand its rescue fund.
"For all the talk of a comprehensive plan, we haven't yet had anything that can be implemented," said Gary Jenkins, head of fixed income at Evolution Securities.
"And then there's the unintended consequences. If you have a template for Greece, then investors may think it's a template for problems elsewhere," Jenkins added.
There are questions over whether a writedown on Greek debt agreed by its private creditors is big enough to put the country's debt back on to a sustainable path, and over how the firepower of the region's rescue fund will be boosted.
Tepid demand at an Italian bond sale last week, which pushed yields at the auction to euro era highs, reflected a lack of conviction the new measures to tackle the crisis were enough.
"To maintain the now fading positive momentum in the markets, the (G20) summit must show results beyond a common statement highlighting the global support on Europe's effort to stir out of the crisis, producing specific, concrete and tangible promises from at least the US, Japan and China that they will invest in the EFSF," Lloyds Bank strategists said in a note.
December Bund futures were 110 ticks higher at 134.77, with 10-year yields down 8 basis points at 2.106 percent, though set to end October around 25 basis points higher than where they started the month.
"We're not seeing too many large-duration plays put on, positioning is pretty flat, or perhaps a bit long," a trader said. We might have had some tactical shorts put on around last week's summit and being pared on Friday so we could be getting some continuation of that."
Belgium sold 2.155 billion euros of 2014, 2017 and 2021 bonds
Belgian bonds underperformed other euro zone issuers, with the exception of Italy with 10-year bond yields 9 basis points higher at 4.42 percent.
"The Belgian auctions were OK rather than strong, as the amount raised was only in the middle of the target range," said Credit Agricole rate strategist Orlando Green.
Traders said spreads coming under pressure before supply was likely to be a recurring theme this week with Spain auctioning three- and five-year bonds on Thursday.
"We are going to get concessions being built as there is not the risk appetite to take paper down. There is money to be put to work but people are going to need incentives," said the trader.
Copyright Reuters, 2011