Italian, Spanish and Portuguese bond yields leapt on Tuesday in one of the most serious episodes of contagion since the height of Europe’s debt crisis after the latest breakdown in talks between Greece and its creditors.
Except for a jump in May during a global bond sell-off driven by improving inflation expectations, yields on bonds issued by the eurozone’s most vulnerable states were on track for their biggest three-day move since mid-2013.
Similarly sharp moves were seen in 2012 as the crisis peaked, although yields on the three countries’ bonds remain far below the highs of above 7 percent hit in that period.
The moves, analysts say, could impact the dynamic of the negotiations between Greece and European leaders, who may have thought that the relative calm in markets during the protracted talks was a sign that investors thought a Grexit was manageable.
“A lot of people, especially in Germany, have seemed relaxed about Greece. We’ve seen comments saying that if Greece exits it’s not such a big thing,” said Jean-Francois Robin, head of rates strategy at Natixis.
“The market is just showing exactly the opposite of that.”
Athens has to repay 1.6 billion euros in loans to the International Monetary Fund at the end of June and an even larger amount to the European Central Bank next month.
Widely believed to be running out of money, Greece is one step closer to default and a possible exit from the eurozone after the latest talks collapsed on Sunday. This could lead to the imposition of capital controls and eventually push it out of the eurozone, analysts say.
Italian 10-year bond yields rose 10 basis points to 2.43 percent. Spanish yields rose 14 bps to 2.52 percent, while Portuguese yields jumped 16 bps to 3.42 percent.
They were all at their highest levels since the third or the fourth quarter of last year. Spanish 10-year yields were on course for their eighth weekly rise in a row, the longest such run since at least 1994.
Greek Finance Minister Yanis Varoufakis said in a German newspaper interview that he was not planning to present new reform proposals at a Eurogroup meeting later this week. But the Greek negotiation team was “available at any time” to find a solution with its partners, Varoufakis said.
Germany’s EU commissioner said on Monday the time had come to prepare for a “state of emergency.”
“There seems to be some panic. It has been said this week would be the week of truth,” said DZ Bank strategist Daniel Lenz, although he thought that assessment was an “exaggeration.”
Even if there is no agreement at Thursday’s meeting of euro zone finance ministers, a deal could still come later, he said.
German 10-year Bund yields, the benchmark for eurozone borrowing costs, were down 4 basis points at 0.79 percent.
The European Court of Justice’s ruling that an ECB bond-buying plan crafted at the height of the crisis was in line with European law had little impact on the market. The plan, called Outright Monetary Transactions or OMT, aims to protect countries that have troubles accessing financial markets with the condition that they pursue reforms.
The OMT, has never been activated but it has been a key driver of the bond market rally that started in 2012 and lasted until recently. It is also seen as an important shield against contagion from Greece. The ECB is currently buying bonds as part of a separate trillion euro stimulus programme to lift inflation.
The aggressiveness of the recent sell-off in peripheral bonds shows, however, the limitations of the safety nets the eurozone has at its disposal. The still relatively low level in absolute yields shows the market has not yet lost hope that a deal can be achieved.
“We expect that an agreement will be reached, although we note that the likelihood of a missed payment is increasing,” said Eirini Tsekeridou, fixed income analyst at Julius Baer.