People look at a board outside Milan's stock exchange.GIUSEPPE CACACE/AFP / Getty Images
Italian bond yields rose close to critical levels that traders fear could spark a steep selloff in the market, potentially forcing Rome to seek a bailout in a repeat of the experience of Ireland and Portugal in the run-up to their rescues.
The European Central Bank's decision to cut interest rates and signals from Greek Prime Minister George Papandreou that he will not call a referendum on last week's euro zone package eased strains in the markets, helping Italian bond markets pare losses.
Italian 10-year bond yields, which have an inverse relationship with prices, jumped to 6.40 per cent at one point – the highest level since September, 1997. It is close to the 6.5 per cent level that markets consider unsustainable. Yields fell back to 6.18 per cent by the end of the day.
In the case of Ireland, it was forced to announce it would seek a bailout only days after its bond yields rose above 6.5 per cent in late October last year. For Portugal, the magic number was considered 7 per cent, a level traders thought would prompt ECB intervention. When the central bank stopped intervening in March, Portugal also swiftly followed Ireland into the rescue unit.
One trader said: "I don't think the ECB can allow yields of Italy to go above 6.5 per cent. The potential for the market to spin out of control at that point is too great. Italy would end up needing a bail-out and the euro zone can't afford to bail out Rome."
Another level markets are eyeing is the extra cost Italy has to pay over Germany to borrow in the markets. Most market participants consider 450 basis points over Germany a danger area, when additional margin fees might be triggered for collateral purposes. However, LCH Clearnet, the clearing house, looks at a spread of 450 bp over a basket of triple-A countries as one factor for charging extra margin fees. Italy is trading at 372 bp over this triple-A basket, while it is trading at 427 bp over Germany.
Greek two-year bond yields also leapt over 100 per cent for the first time on two-year debt, according to Bloomberg, highlighting the breakdown of the country's debt market. These two-year bond yields were trading at 30 per cent in August. However, there is very little liquidity in the Greek bond market with bankers mostly marking up yields rather than pricing them on actual trades.
In spite of worries over Italy and Greece, both France and Spain managed to sell bonds in the market. France sold €6.05-billion ($8.36-billion U.S.) of six year, 10-year and 15-year government bonds, while Spain sold €4.49-billion of three-year and five-year bonds.