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* Greek yields hit 2014 high amid emerging market rout
* Spain, Italy insulated by large domestic investor holdings
* Recent Portuguese debt sell-off raises market return worry
By Marius Zaharia
LONDON, Jan 27 (Reuters) - Greece's government bond yields hit their highest this year on Monday with the country seen as the most vulnerable in the euro zone to a spillover from an emerging market sell-off.
Bond yields in Portugal, seen as the region's other weak link in, fell. However, traders said volumes were low and analysts cautioned yields could rise again if the emerging market rout deepens.
Tighter credit conditions in China and expectations the Federal Reserve will further scale back its monetary stimulus have fuelled large outflows from developing markets, with currencies in Turkey, Argentina and Russia hitting record lows.
The sell-off hit junk-rated Greek and Portuguese bonds more than other euro zone debt. By contrast, Spanish shares were among the worst hit due to their exposure to Latin America.
Two-thirds of Spanish bonds are held by domestic investors, who are less likely to sell when global sentiment towards risky assets sours. By comparison, only about half of Portuguese bonds are owned by locals, making the country more vulnerable to such shifts.
At a sale of 10-year bonds last year, only 14 percent were sold to Portuguese investors, debt agency data shows. UK and U.S. buyers took larger chunks.
At Spain's 10-year bond sale last week, 39 percent went to domestic investors, according to a primary dealer.
Data on Greece was not immediately available, but traders say many of the bonds are in the hands of foreign hedge funds, many of them based in the United States.
Bailed-out Greece and Portugal have also lured investors with mandates to invest in emerging markets as their yields are close to those in similarly-rated developing economies. The duo have dropped out of the main euro zone bond indexes due to their ratings so count on a significantly different investor base than do other euro zone states.
"It comes down to who owns it," said Hans Humes, chief investment officer at Greylock Capital, referring to Greek debt, which the firm owns. "The big holders are people who own emerging markets. We haven't completed the transition to make Greece part of the euro zone fixed income universe again," said Humes, a veteran of distressed debt markets.
Greek 10-year yields rose 12 basis points to 8.75 percent, having earlier hit a five-week high of 8.90 percent, according to Reuters data. This followed a 20 bps rise on Friday when the emerging market sell-off was more intense.
Equivalent Portuguese yields fell 7.5 bps to 5.22 percent, but remained over 20 bps above Thursday's close.
"This shows that Portugal is much more euro zone periphery than Greece is. Greece is still in the emerging market camp," said Commerzbank rate strategist David Schnautz. "But given its ratings are junk, Portugal remain vulnerable to external unfavourable developments such as those in emerging markets."
Italian and Spanish yields were flat on the day and less than 10 bps higher than on Thursday.
Portuguese bonds' initial reaction to the emerging market tensions triggered worries that Lisbon may need some form of financial assistance when its EU/IMF bailout deal ends later this year, said Gianluca Ziglio, an analyst at Sunrise Brokers.
"The situation shows that whatever happens in the world is also going to affect Portugal's ability to have market access at an acceptable rate," he said.
Yields on German 10-year Bunds, the euro zone benchmark seen as one of the safest assets in the world, were flat at 1.66 percent, having fallen 5 bps on Friday.