Euro bond spreads hit record as panic grips markets

By Ambrose Evans-Pritchard
The Telegraph, London
Wednesday, March 5, 2008

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/03/05/cnbond...

Investors sold Italian and Greek debt yesterday in signs of near panic liquidation, driving bond spreads to the highest level since creation of the single currency.

The yields on Italian 10-year government bonds reached 52 basis points above German bunds, approaching levels that risk setting off a self-reinforcing spiral of investor flight.

Spreads on Greek bonds also jumped to 52.

The wild moves on the euro-zone bond markets came as gold plummeted by $29 an ounce to $957 on automatic stop losses and forced selling by funds. Crude oil futures tumbled almost $3 a barrel in New York.

The Dow Jones index fell 226 points at one stage.

Traders said the market was swept by rumours that a distressed hedge fund was being forced to sell profitable contracts to meet margin calls, triggering a cascade of sales in loosely correlated assets.

"We're in the middle of a big panic in the market," said David Keeble, a strategist at Calyon. "There are simply no buyers for anything with even slight risk on it."

The grim mood caused a reflex flight to safety, boosting bunds and refuge currencies such as the Swiss franc and the yen.

Funds dumped bonds from the more vulnerable emerging markets and picked off the weakest members of the euro-zone.

"There are forced sellers out there having to liquidate assets," said Dominic Konstan at Credit Suisse. "There are also people out there who always felt EMU wouldn't work and this is bringing them out of the woodwork. The blowing up of the spread does not help sentiment and these things can become self-fulfilling."

Mounting evidence that Italy is sliding into recession have raised fears of a ballooning fiscal deficit, putting the country's debt trajectory on an unsustainable course. The collapse of Romano Prodi's government has left Rome in limbo and raised doubts about the viability of economic reform.

The rating agencies have already downgraded Italian debt twice. A growing number of banks have advised clients to take "short" bets against Italian debt, including Goldman Sachs and BNP Paribas.

Simon Derrick, currency strategist at Bank of New York Mellon, said flow of funds data show that foreign investors have suddenly liquidated half the Italian and Greek governments bonds accumulated over the last four years.

He said the markets were starting to price in risk that these countries would be hit much harder than Germany by the strong euro and a cyclical downturn. Brussels has halved its growth forecast for Italy to 0.7 percent this year.

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