Yields on Spanish government bonds remained close to euro-era highs Tuesday on fears that Spain would need a formal bailout but the rally in German Bunds was halted after Moody's Investors Service cut the outlook on the triple-A rating of Germany, the Netherlands and Luxembourg to negative, citing contagion risks from peripheral member states.
Spanish benchmark 10-year government bond yields initially eased off Monday's high of 7.59% before climbing eight basis points from Monday to 7.53%, according to Tradeweb.
However, they didn't extend gains after Catalonia said it would ask the Spanish central government for financial aid, in contrast to the moves seen Friday after Valencia made such a request.
Shorter-dated Spanish bond yields also rose while Spanish default insurance costs pushed higher Tuesday, with its five-year credit default swap moving four basis points wider to 628 basis points, according to data-provider Markit.
The difference between 10-year Spanish and German bond yields widened to around 630 basis points.
The corresponding Italian bond yield rose 16 basis points to 6.47%.
"We're resuming the trend wider and there's nothing to stop it. For the yields to change, someone has to decide it's time to buy," said Peter Chatwell, interest rate strategist at Credit Agricole in London.
Spain was still able to drum up robust demand at a sale of shorter-dated securities, selling 3.05 billion euros ($3.69 billion) of three- and six-month Treasury bills at Tuesday's auction, a shade higher than the upper end of its indicative range. Average yields edged up at auction but were comfortably below the levels hit back in November.
But the rise in longer-dated yields in the secondary market suggests that investors remain cautious of holding Spanish debt and prefer securities deemed safer. This was demonstrated through the strong demand at a Dutch bond sale Tuesday where two-year bonds had an average yield of just 0.003%, down from 0.523% at the last sale.
Moody's warning on Germany's triple-A rating ensured German Bunds didn't benefit from the downbeat mood in what London traders said was a thin market. The September contract fell to as low as 144.51 from Monday's close of 145.55.
At 1230 GMT, the September Bund futures contract was down 67 ticks at 144.88.
But despite the sharp sell-off, a London-based trader said he would be wary of selling Bunds at these levels and would need to see them down around 144.00 or even 143.70.
Gilts tracked German Bunds lower, but the sell-off was less severe, with the September contract down around 0.2 from Monday's close of 121.81.
Write to Jessica Mead at jessica.mead@dowjones.com
(Neelabh Chaturvedi, Karen Hage and Art Patnaude contributed to this article.)
