That appears to be the message sent by rising Spanish and Italian bond yields – and widening spreads between peripheral yields and German bunds – in recent days, strategists say.
Italian and Spanish government bond prices were both under pressure again Thursday, sending yields higher after the latest round of euro-zone purchasing managers index readings showed a contraction in euro-zone business activity deepened in March. Italy’s 10-year yield IT:10YR_ITA jumped 0.08 percentage point to 5.09%, while Spain’s 10-year yield ES:10YR_ESP rose 0.10 percentage point to 5.51%, according to electronic trading platform Tradeweb.
More importantly, the premium investors demand to hold either country’s debt over good old reliable German bunds widened substantially for a second day. Investors now want 3.17 percentage points extra yield to hold 10-year Italian paper over 10-year bunds DE:10YR_GER -3.34% , a rise of 0.15 percentage point. Spain requires a 3.57 percentage point premium, a rise of 0.17 percentage point. Italian bond bulls just last week were celebrating as the 10-year Italian/German spread narrowed to less than 3 percentage points for the first time since August.
The European Central Bank’s decision to flood the financial system with liquidity via its three-year long-term refinancing operations in December and February is credited with going a long way to ease tensions. Fears of a near-term credit crunch or a funding-related bank failure faded, while institutions hungry for yield used cheap financing to grab Italian and Spanish bonds, helping pull down yields and further ease tensions.
The situation, of course, is still removed from the panicky state of late 2011. But while peripheral yields remain far below the crisis levels seen late last year – Italy’s 10-year yield IT:10YR_ITA +2.56% topped an unsustainable 7% — and spreads have narrowed significantly, strategists increasingly worry that the trend has once again reversed.
But the weak euro-zone PMI readings coupled with mounting fears of a hard landing in China are once again stoking fears, said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co. In New York, particularly as investors weigh the prospect of the ECB looking for an exit strategy after providing more than a trillion euros ($1.31 trillion) in liquidity.
“The data is a wake-up call for the euro zone. Investors have responded by driving European equity markets decidedly lower not too long after piling in on the presumed prop from the ECB’s intervention during the last three months. The safety of bonds came back onto the radar screen as a result, but that cracked open renewed concern for peripheral government bonds raising the question of whether the honeymoon might be over,” he said, in emailed comments.
“The next challenge is how, despite sticking to its dogmatic austerity position, the French and German governments can help deliver a growth strategy,” he said.
