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Spain watched as Greek restructuring worries grow

Source: Reuters - Mon 18th Apr 2011

Growing talk about a Greek debt restructuring weakened fringe euro zone bonds and hit demand at a Spanish Tbill tender on Monday, placing Madrid's upcoming bond sales under closer scrutiny for signs of rising contagion risks.

A Greek daily report that the country told the International Monetary Fund and the European Union that it wants to restructure its debt, fuelled further stress in the markets after last week's suggestion by Germany that it may support such a move.

With some analysts saying significant haircuts were already priced in by bond markets, the recent weakness in peripheral bonds was attributed mostly to uncertainty over the ramifications of such a move.

All eyes were on Spain, which sold 18-month bills at a premium of almost one full point higher from the previous auction and whose bonds were close to erase all their gains since mid-March when a pledge to increase the size of EU's EFSF aid fund spurred bets the country was bailout risk-free.

"The sharp rise in the cost of funding will ... bring the debate back to the contagion issue," said UniCredit strategist Chiara Cremonesi. "I would say that the decoupling of Spain from the weakest of periphery has come to a halt for the time being but it is too early to speak about a contagion."

Spanish ten-year yields were up 18 basis points on the day at 5.6%. This compared with a rise in equivalent Greek yields of 27 bps to 14.308% and with an 8 bps increase in Italian ten-year yields to 4.9%.

"At the moment Spain can still be the master of its own destiny, it's not completely at the mercy of the market," said Colin Ellis, chief economist at BVCA.

"Ten-year (paper) is still on the market for about 5.5%, that is clearly edging towards uncomfortable levels, but it's not above the bar yet. The moves put pressure on the Spanish government and are a reminder that it really has to move decisively to demonstrate its commitment to fiscal credibility."

WestLB strategist Michael Leister said the rise in Spanish yields was probably due to investors using the headlines on Greece as a reason to book profits after Spain's recent rally but contagion risks could increase if yields rose much further.

"For the very short term, with regard to the upcoming auctions anything near 6% or even 5.75% will definitely raise some eyebrows," he said.

Spain issues 10- and 13-year paper on Tuesday, with details to be announced later in the day.


Greece's five-year credit default swaps rose 84 bps on the day to a new record high of 1,220 bps and the Greek/German 10-year government bond yield spread was last 11 basis points up on the day at 1,079 bps. Thin trade ahead of a long weekend was exacerbating moves, traders said.

Equivalent Portuguese/German spreads rose by a similar amount, getting close to 600 bps, also hurt by uncertainty over the country's pending bailout deal after a Finnish anti-euro party, which pledged to veto the rescue, scored big in polls.

The Finnish parliament, unlike others in the euro zone, has the right to vote on EU requests for bailout funds, meaning it could block funding plans for Portugal.

Bond strategists still expect Finland to give green light to funding for Portugal eventually, and the market reaction was more related to signs of growing opposition towards steps to help weaker countries get on top of the European debt crisis.

"There is increased support to euro-skeptical parties and this may make EU leaders a bit more cautious going forward when negotiating attempts to solve the debt crisis," said Niels From, chief analyst at Nordea.

"This is weakening the firepower of the euro system."

Bund futures broke a key technical resistance level at 121.41 - the 38% retracement of the May-April fall - last trading up 31 bps on the day at 121.51. A close above 121.41 would open the way for gains towards the 62% retracement of the fall at 122.37.

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