The European Central Bank again stepped into government bond markets to buy debt issued by the Italian and Spanish governments, whose borrowing costs spiralled higher Friday on concerns over the euro-zone financial system.
The yield on 10-year Italian government bonds moved up to 7.12% as investors sought higher risk premiums, returning Italian borrowing costs to levels deemed unsustainable over the longer term. At that level, the Italian government must pay 5.24 percentage points more than German yields at that maturity.
The ECB buys government bonds in the secondary market as part of its Securities Markets Program, where it intervenes in secondary bond markets to ensure depth and liquidity in dysfunctional market segments.
That describes Italian and Spanish bond markets in recent weeks, where borrowers are demanding increasingly high yields on two-year and other shorter-dated debt to offset the risk that those governments will fall into the same fiscal traps that caused Greece, Ireland and Portugal to seek external aid last year.
Two-year Italian government bonds yield 4.94%, or 4.76 percentage points over German bonds.
Investors also are believed to be factoring in another risk factor. Italian bond spreads over the German benchmark are entering the "red zone" where the two main clearing houses of Italian debt may increase their margin requirements. This means that traders would need to increase the amount of cash or securities deposited with the clearing house in order for them to trade Italian government bonds.
Another concern is an impending surge in new debt issues.
Investors had already begun the year worried about governments' funding needs, with euro-zone governments' gross issuance for 2012 forecast to be €794 billion ($1.015 trillion), according to research by Barclays Capital.
Spain and Italy are both expected to begin their 2012 financing next week. Spain is looking to raise around €5 billion by selling shorter-dated bonds on Jan. 12, while Barclays Capital estimates Italy is looking to raise around €7.5 billion from a sale of three-year, four-year and 15-year Buoni del Tesoro Poliennali, or BTPs, on Jan. 13.
European banks continue to hoard cash amid concerns of counter-party risk within the European financial system, preferring to park funds at the ECB rather than to lend out to other banks or invest in government bonds. Depressed bond prices indicate that little of the ECB's €489 billion infusion of three-year funding at the end of December found its way into government bonds.
"If we don't get a crisis resolution soon, concerns over the euro-zone debt situation are likely to continue to dominate trading," said Richard McGuire at Rabobank.
read more: Olympus Wealth Management
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