Greek referendum plan pushes Bunds to 1-month high

LONDON: German Bund yields plunged on Tuesday and were expected to retest record lows, after Greece's call for a referendum on its new bailout deal raised risks of an uncontrolled Greek default which could send shock waves throughout the euro zone.

The 10-year government bond yield spreads of Italy and Belgium versus Germany hit euro era highs and the equivalent French spread traded close to their euro record as some analysts said such a move raises the odds for the worst case scenario -- a euro zone break-up.

"If it gets rejected, the Greek public decides that Europe is not for them. The risk of a return to drachma suddenly increases," said Eric Wand, rate strategist at Lloyds, adding that Bund yields could re-test their record lows of 1.637 percent.

Bund futures last traded 183 ticks higher on the day at 137.30, having hit their highest since Oct. 5 at 137.61 earlier in the session. Ten-year German yields were down 17.9 basis points at 1.848 percent.

Technically, if the austerity-fatigued Greeks reject the deal -- and opinion polls suggest this is likely -- snap elections may be triggered. This is also a risk if the government loses a confidence vote in parliament on Friday, but analysts believe that is less likely to happen.

Questions emerge, then, on whether the private sector would still 'voluntarily' agree to a 50 percent loss on its Greek debt holdings given the shaky political environment.

"There are so many questions, for example, what happens to the package that was due to be paid over fairly shortly? Is it now going to be paid? If not, Greece is going to default in December, it hasn't got enough cash," said Russell Silberston, head of global interest rates at Investec Asset Management.

Silberston, who manages about $31 billion globally, said Investec has not held any peripheral debt for the last few years. Despite a widening in French spreads, he is still "quite relaxed" and "happy" to hold French debt.

"France is still very solvent, it is still trading like a bond market rather than a risk asset. If you begin France trading like a risk asset then you would have to be very careful, but at the moment it is not," he said.

French 10-year yields were down 7 bps to 3.04 percent, signalling France's debt -- recently under pressure due to speculation the country may lose its triple-A credit status -- was still benefiting from the flight to quality.

ITALY RISK

Investors were already risk averse before the announcement of the referendum plans as the latest package of measures euro zone leaders put together -- including bank recapitalisation plans and leveraging the EFSF rescue fund -- lacked details.

The Group of 20 leaders meeting later this week could offer more information about how the EFSF would be leveraged and whether countries such as China or Japan might contribute with funds, but the referendum plan risks made them even more reluctant to invest in euro zone assets, analysts said.

Italian 10-year BTP yields were up 15 bps to 6.25 percent, with spreads over Bunds at euro lifetime highs of 436 bps. The curve flattened further, with the two-year Italian/German yield spread also at euro era highs of 476 bps.

"I see the risk they slip further, the ECB (bond-buying programme)needs to be increasingly more powerful in order to maintain the status-quo," Lloyds' Wand said.

"Going into year-end liquidity will fade. We've seen this before, things can slide away pretty rapidly ... If we get to 6.50 (percent in 10-year yields) then 7 will be rapidly on the cards and then we're getting in a situation that nobody wants."

Copyright Reuters, 2011