LONDON: Spanish bond yields edged lower on Tuesday after last week's surprise euro zone deal to remodel the region's rescue fund, but further sharp falls were seen limited as doubts over implementation set in.
Markets' euphoria over Friday's deal to allow the region's permanent ESM fund to buy bonds in secondary markets has dimmed as investors turned to potential risks such as the insufficient size of the rescue fund and the ratification process in each member state.
Finland and the Netherlands, two of the currency bloc's most hardline creditor states, cast doubt on the deal after Finland said Helsinki and its Dutch allies would block the ESM from buying bonds in the secondary market. Spain's Economy Minister Luis de Guindos hit back on Tuesday saying individual countries had no capacity to block such agreements.
Investors were also fretting over the risk of Germany's powerful constitutional court delaying the entry into force of the ESM and possibly placing restrictions on its scope of action.
"I find it a little bit difficult to justify further declines in peripheral yields given the fact that there seems to be some opposition against giving the ESM the authority to buy debt in the secondary market," said Marius Daheim, senior fixed income strategist at Bayerische Landesbank.
"In Germany we have a few legal problems with the ESM as well and the constitutional court has to decide on that next Wednesday. That doesn't look like a smooth transition towards large scale bond purchases by the ESM."
Spanish 10-year yields slipped 4 basis points to 6.36 percent with five-year yields 6 basis points lower at 5.54 percent but the moves lacked conviction before a debt sale on Thursday. The auction of up to 3 billion euros of Spanish bonds will be the first test of market sentiment towards Spain since the EU summit on Friday.
Italian 10-year yields were steady on the day at 5.73 percent, having fallen more than 60 basis points from late Thursday's levels.
RBC strategists said they remained wary of Italian and Spanish debt given concerns about the euro zone rescue funds' capacity for meaningful intervention in the secondary market.
"Thus, despite the quite positive reaction of spreads to the outcome of last week's EU summit we remain sceptical that Spanish government bonds and Italian BTPs can find lasting support for now," they said in a note.
"Against this backdrop and with supply pressure building up again we remain well clear of direct spread exposure with respect to BTPs and Spanish bonds against Bunds and see better risk/reward within the core space."
ECB EYED
German Bund futures fell 21 ticks to 141.47 while 10-year cash yields were up slightly at 1.53 percent as some dealers made way for new supply from triple-A-rated Netherlands whose debt offers a p remium over German counterparts. The Dutch State Treasury aims to raise 4 billion euros ($5.03 billion) from the sale of the 5-year bonds.
Activity was subdued ahead of the US Independence Day holiday on Wednesday with traders seeing little scope for a further sell-off in Bunds before a European Central Bank meeting on Thursday widely expected to cut interest rates.
"It almost feels like the selling in Bunds was done before the summit plus we're getting into a week where potentially the ECB are going to cut rates and are going to be dovish so core rates are getting some support," one trader said.
A majority of analysts expect the ECB to move to support the region's economy by cutting its main refinancing rate by 25 basis points to 0.75 percent at its policy meeting on Thursday.
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