Spanish, Greek, Italian Bonds Rise, Bunds Slump on Loan Extension Report

Spanish, Greek and Italian 10-year bonds jumped while bunds slumped after a media report said a draft document of conclusions from the European Union summit today calls for an extension of bailout loans for Greece.

Loans from the European Financial Stability Facility may be lengthened to 15 years from 7 1/2 years and offered at a rate of 3.5 percent, according to Reuters. Yields on benchmark German bunds climbed to the highest in almost two weeks after German Chancellor Angela Merkel and French President Nicolas Sarkozy agreed on a joint position to solve Greece’s debt crisis. Luxembourg Prime Minister Jean-Claude Juncker said a so-called “selective default” is a possibility for Greece.

“The market reaction has been one of an expected sigh of relief for risk assets and a sell-off in safe havens,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. “There are still no details but certainly the bar has been raised very high in terms of an expectation that an agreement will be reached.”

Spanish 10-year bonds rose for a third day, lowering yields 25 basis points to 5.73 percent as of 4:59 p.m. in London. That reduced the spread, or yield difference, over benchmark German bunds to 285 basis points. Two-year Spanish note yields were 39 basis points lower at 3.77 percent.

Italian 10-year yields dropped 26 basis points to 5.34 percent, narrowing the yield gap over bunds to 247 basis points. Yields on equivalent-maturity Irish bonds sank 71 basis points to 12.35 percent. Greek 10-year yields slumped 85 basis points to 16.49 percent, after sinking to 16.45 percent, the lowest since July 5.

‘Short-Lived’ Rebound

Speculation on what measures European leaders may introduce to stem the euro-region’s sovereign-debt crisis comes as officials meet in Brussels in an attempt to find a comprehensive solution on how to fund a second Greek bailout. Disagreement has so far centered on whether private holders of the nation’s debt should be compelled to contribute to the rescue, a measure that ratings companies have warned would constitute a default.

“The recent rebound in periphery markets may prove short- lived if the outcome of the meeting falls short of expectations,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London.

German benchmark 10-year yields increased 11 basis points to 2.88 percent, after reaching 2.90 percent, the most since July 8. Yields on two-year German notes rose 12 basis points to 1.42 percent.

In addition to further bailout loans for Greece, the EFSF may be permitted to intervene in secondary bond markets, depending upon European Central Bank input, and recapitalize financial institutions through government loans, Reuters said.

Restructuring ‘Disaster’

ECB Executive Board member Lorenzo Bini Smaghi told Die Welt yesterday that governments should bury their plans to involve private Greek bondholders.

“A restructuring would be a disaster” and “far more costly for the taxpayer than granting Greece another aid package with conditions,” Bini Smaghi was quoted as saying.

German Deputy Foreign Minister Werner Hoyer said his nation may back common euro bonds in the future as legal rules bar such a move for now.

“If we further develop the European Union towards a political union, then the question of liability via euro bonds is an option,” Hoyer said in a telephone interview. While euro bonds are “obviously not” on the cards at today’s meeting, Germany will demonstrate how it’s “fully committed” to solving the crisis, he said.

Spanish Auction

German bund futures expiring in September declined for a third day, dropping 0.9 percent to 127.01. Italian bond futures expiring in the same month rose 2 percent to 104.08.

Spain sold 2.62 billion euros of 10- and 15-year bonds at an auction, the Bank of Spain said, compared with a maximum target of 2.75 billion euros.

The so-called bid-to-cover ratio for the 10-year securities declined to 1.9 from 2.13 at a sale in June. The ratio for the 15-year bonds dropped to 2.08 from 2.57 in June.

German government bonds have handed investors 1.7 percent this year, compared with 3.6 percent for U.S. Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Greek bonds have lost 21 percent, while Portugal’s declined more than 27 percent.

To contact the reporter on this story: Garth Theunissen in London gtheunissen@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net