Italian, Spanish Bonds Slump Amid Concern EU Plan Lacks Necessary Support

Italian and Spanish securities slid amid concern measures to support the region’s most indebted nations may struggle to win support from euro-area members.

German 10-year yields fell the most in almost two weeks. Slovakia’s SaS party, which the governing coalition needs to secure a parliamentary majority, today said it opposes the country’s participation in a permanent euro aid fund, bolstering a temporary fund and rejects the terms of the Greek rescue package. German bonds rose for a second day as U.S. lawmakers reached an impasse over raising the nation’s debt ceiling, boosting the odds of a default as soon as next week.

The Slovakian opposition “doesn’t read particularly well,” said Harvinder Sian, a senior fixed-income strategist at Edinburgh-based Royal Bank of Scotland Group Plc. Last week’s European agreement is “a poor plan, and it could blow up at any point,” he said.

Italy’s 10-year government bond yield surged 26 basis points to 5.67 percent, as of 4:27 p.m. in London. The spread, or yield gap over benchmark 10-year German bunds widened to 290 basis points, while two-year yields climbed 37 basis points to 4.02 percent.

The Spanish 10-year yield jumped 26 basis points to 6.02 percent. Ten-year bund yields dropped eight basis points to 2.75 percent. The 3.25 percent security maturing in July 2021 gained 0.67, or 6.7 euros per 1,000-euro ($1,438) face amount, to 104.26.

Greek Plan

Greek two-year government notes snapped three days of gains after Moody’s Investors Service today downgraded the nation’s sovereign credit rating three steps, driving the yield 50 basis points higher to 28.13 percent.

Euro-area leaders last week unveiled 159 billion euros of new aid for Greece as well as new powers for the 440-billion euro rescue fund. Banks will voluntarily agree to write down the value of their Greek securities by 21 percent as part of the bond exchange and debt buyback program, the Institute of International Finance said July 22.

The debt deal “implies that the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100 percent,” Moody’s said in a statement.

“We think EU policymakers have surprised the markets by a wide range of measures, but many points are still not clear,” Giuseppe Maraffino, a fixed-income strategist at Barclays Capital in London, wrote in an investor note today. “We would expect some continued volatility and contagion, but probably less extreme relative to recent behavior, before more details about the plan will be clear.”

U.S. Debt Ceiling

The risk of bank writedowns and more contagion from the debt crisis helped to drag the Stoxx 600 Banks Index down by as much as 3.2 percent today. Italian and Spanish banks including Banca Popolare di Milano Scrl, Intesa Sanpaolo SpA and Bankinter SA lost at least 4 percent.

The failure of U.S. officials to reach an agreement on the debt ceiling boosted demand for bunds, which traditionally benefit in times of financial turmoil.

House Speaker John Boehner plans to press ahead with a shorter-term increase of the limit than President Barack Obama has requested, he told lawmakers yesterday, defying a veto threat and signaling continued stalemate in the U.S. Congress as time runs short for a deal.

Boehner told rank-and-file Republicans that they needed to pull together to block Obama, who has asked for a $2.4 trillion borrowing boost in the $14.3 trillion debt ceiling, without any guarantees of spending cuts, according to a person familiar with the discussion.

U.S. AAA Rating

The U.S. may lose its AAA rating even if lawmakers reach a plan to avoid a default, according to Mohamed A. El-Erian, whose Pacific Investment Management Co. is the world’s largest manager of bond funds.

“In most likelihood, a last-minute political compromise will avoid a default but will leave the AAA rating extremely vulnerable,” El-Erian, the Newport Beach, California-based chief executive officer and co-chief investment officer at Pimco, wrote in an e-mail.

“The dominant factor is what’s going on in the U.S.,” said Charles Diebel, head of market strategy at Lloyds Bank Capital Markets. “You could end up with a scenario where they just kick the can down the road and the ratings agencies downgrade them. It should help bunds on the spread.”

Belgian bonds pared declines after the nation auctioned around 2.5 billion euros of debt maturing 2017, 2021 and 2041. The 10-year yield gained four basis points to 4.30 percent, after earlier rising to 4.33 percent. Germany sold 2.5 billion euros of 12-month bills today, while France plans to auction 8 billion euros worth of 91-, 182-and 336-day bills.

German government bonds handed investors 1.3 percent this year, compared with 3.5 percent for U.S. Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Greek bonds have lost 9.4 percent, while Portugal’s have declined 23 percent, the indexes show.

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net. Paul Dobson in London at pdobson2@bloomberg.net

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

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