Short-dated Spanish bond yields rose further, albeit at a slower pace than on Monday, but traders saw little respite as expectations grew that the country will need a full bailout on top of an already approved rescue for its banks.
The potential cost to the so-called core euro zone members of Spain and Italy requiring further support was one of the reasons cited by Moody's for changing Germany's outlook and those of the Netherlands and Luxembourg, along with the cost of containing fallout from a possible Greek euro exit.
Greece's international lenders return to Athens on Tuesday to decide whether to keep the country on its 130-billion-euro life support line. Athens has fallen behind target on implementing reforms undertaken as part of the bailout deal.
But analysts said with a "sizeable" investor base obliged to invest in euro-denominated assets, the sell-off in Bunds was likely to be temporary and they would remain the safe haven of choice.
"If we're to get to a solution to the debt crisis it can only be through fiscal unity which points to higher core yields and ratings potentially coming under pressure," said Richard McGuire, interest rate strategist at RBC Capital Markets.
"But in order to get to the point where core sovereigns assume the liabilities, things must get worse and that points towards lower yields in the short term, particularly for Germany."
With Standard & Poor's already assigning Finland a negative outlook, no euro zone country has a stable outlook on it triple-A rating from all three major credit agencies.
Bund futures were down 79 ticks on the day at 144.76, with 10-year yields up 7.7 basis points at 1.25 percent.
Traders said they were seeing selling of German paper by both long-term investors and "fast-money" accounts, such as hedge funds, as well as by dealers.
Bunds have underperformed both US Treasuries and UK gilts this week, something one trader called an "anti-euro bias.
"It's a hard call given what's happening in the periphery and if you have to stay in the euro zone, you're going to stay in Bunds," he said.
The Netherlands will sell two- and 15-year bonds and should find decent demand given the small additional yield paid over German paper, but Spain is likely to have to pay a high price to issue 3 billion euros of three- and six-month bills after yields on its debt soared on Monday.
Spanish bond yields have soared to euro-era highs on concern the government might lose access to funding markets and need a full bailout, which would drain the euro zone's rescue funds at their current capacity.
Spanish Economy Minister Luis de Guindos ruled out a full-scale financial rescue but the rise in yields showed markets were unconvinced.
Ten-year Spanish yields were 10 bps higher at 7.59 percent but five-year yields rose above 10-year yields for the first time since June 2001.
Short-dated yields have risen more than longer-dated ones, flattening the curve, because of a perceived rise in credit risk.
Two-year yields were up 16 bps at 6.77 percent after rising almost a percentage point on Monday after media reports on Sunday that up to half a dozen local authorities were ready to follow Valencia in asking for government aid.
After the recent surge in yields on Spanish and Italian bonds, clearing house LCH.Clearnet increased the cost of using debt issued by the two countries to raise funds via its repo service.