* Spanish bonds hit by two-notch downgrade to BBB+
* Italian yields also rise despite smooth auction
* Focus likely to turn to U.S. data for signs of recovery
By William James
LONDON, April 27 Spanish bond yields rose to the
6 percent danger level on Friday after a credit rating downgrade
stoked fears about the euro zone's heavy debtors, with a smooth
Italian debt auction providing only limited relief.
Standard & Poor's cut Spain's credit rating by two notches
to BBB+ late on Thursday and maintained a negative outlook,
citing the deterioration of government finances and weakness in
the Spanish banking sector.
In reaction, the 10-year Spanish bond yield
hit a high of 6.03 percent, up 18 basis points on the day. The
rise also reflected weak Spanish retail sales data and the
threat of further downgrades.
"It's difficult to see where any good news for Spain comes
from ... people are perhaps taking the view that now the
downgrade has come for Spain, what could happen to Italy on that
front?" said John Davies, strategist at WestLB in London.
The Spanish yield has briefly broken above 6 percent several
times in recent weeks. Markets are wary that a sustained move
would draw comparisons with the swift rise to an unsustainable 7
percent seen in Portuguese and Irish yields before both
countries sought international bailouts.
The scale of the region's debt problems were highlighted by
S&P's head of European ratings, Moritz Kraemer, who said there
were downside risks to almost all euro zone sovereign ratings.
Nevertheless, Italy was able to negotiate a potentially
tricky bond sale with the minimum of fuss, selling 5.95 billion
euros of BTPs and avoiding the poor show of demand that some had
feared following the deterioration in sentiment.
"To sum up, at least no further bad news, nothing to provide
further fuel to the sell-off we have had in periphery paper this
morning," said Michael Leister, strategist at DZ Bank.
The 10-year Italian bond yield rose 14 bps in
early trade to hit 5.78 percent - its highest level since the
beginning of February. It was last trading at 5.74 percent as
the smooth auction took some of the heat out of the selloff.
NEW BUND HIGH
German Bund futures rallied to a record high 141.38
as investors sought out low-risk assets, but retreated after the
Italian auction to stand 4 ticks higher at 140.96.
However, with peripheral yields at elevated levels - 10-year
borrowing costs rose by 60 bps compared with a month ago at the
Italian auction - Bunds were likely to remain the investment of
choice for those looking to cut back on risk.
"Even though Italy and Spain have come back from their
wides, the market there still seems a little soft... they say
'don't ever be short Bunds on a Friday', so we could get back up
a bit towards new highs," a trader said.
After euro zone data earlier this week painted a grim
outlook for the region's economy, investors' next focus will be
the health of the U.S. recovery when it unveils first quarter
output figures at 1230 GMT.
The data is expected to show the rise in gross domestic
product slowing to an annualised rate of 2.5 percent from 3
percent in the previous quarter.
Economic growth is an essential component of Spanish and
Italian plans to escape their towering debts and any negative
surprise from the world's largest economy would fuel selling
pressure on riskier euro zone bonds.
"We're back in that situation where we have euro zone
troubles and at the same time concerns about the strength of the
U.S. recovery," said Philip Marey, strategist at Rabobank in