LONDON: A broadly successful sale of Italian bonds on Thursday did little to soothe worries the euro zone crisis was set to deepen again, sending Italian and Spanish yields higher as investors switched into low-risk German debt.
Both Italy and Spain are faced with the difficult task of pushing through unpopular reforms to shore up public finances and regain the confidence of wary bond investors - leaving markets on edge and trading volatile.
Italy's auction of five- and 10-year debt drew solid demand from primary dealers who can bid at the auction, allowing Milan to issue at the top end of its target range, but the country's bonds were being sold in secondary markets soon after.
"The five-year auction went well, the bond was issued 10 cents above the market prices during the bidding. The 10-year softened a bit, probably because in this kind of environment, no one really wants to add the duration," said Gianluca Ziglio, strategist at UBS in London.
"Definitely there's been some selling after the auction it was mainly in reaction to the 10-year auction. The market in this kind of circumstance tends to look towards the empty portion of the glass."
Italian 10-year yields rose to a one-month high of 5.24 percent, up 14 basis points on the day while five- and two-year debt rose by 16 and 18 basis points respectively.
Selling pressure was also seen in other peripheral markets, particularly for Spanish debt where investor appetite faltered ahead of Friday's highly anticipated budget announcement, and as workers took strike action to protest against sweeping reforms.
"There's Spain's budget tomorrow, a general strike today - it all feels like it's blowing up again," a trader said.
Spanish 10-year yields climbed 12 bps on the day to 5.45 percent, driving the spread over German Bunds to its widest since early January at 363 basis points.
BUND BIAS
German debt futures hit a high of 138.28, but subsequently eased to 138.16, 30 ticks higher on the day. A closing break above this level, the 76.4 percent pullback of the selloff seen this month, would be a fresh bullish signal, one trader said.
They have risen around 250 ticks over the past seven sessions as worries about euro zone growth and weak peripheral states have come to the fore, erasing almost all of a steep US-led sell-off that was driven by a better outlook on the world's largest economy.
That has left 10-year German yields at 1.82 percent, well below the 2 percent psychological barrier and trading toward the lower end of the 2.05 to 1.75 trading range that has broadly held this year.
Finance ministers will seek on Friday to calm some of investors' worst fears by discussing how to strengthen the euro zone's defences against the spread of the debt crisis, but lasting relief in the market was unlikely.
A draft Eurogroup statement showed the combined capacity of the euro zone's bailout funds was set to be 700 billion euros until mid-2013, with the possibility of an increase to 940 billion euros in exceptional circumstances.
"Most of this good news already seems to be in the price and investors may need to see much better macro data to revive the upward momentum in risk assets," Lloyds Bank strategists said in a note.
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