April 23, 2012 / 4:10 PM / 7 years ago

EURO GOVT-Dutch debt leads broad sell-off as crisis spreads

* French vote, Dutch political crisis rattle investors

* Dutch/German 10-year yield spread widest in three years

* German 10-year yields hit record low

* Netherlands bond sale on Tuesday to test sentiment

By Kirsten Donovan and Emelia Sithole-Matarise

LONDON, April 23 (Reuters) - Dutch and peripheral euro zone bonds sold off on Monday and German Bund yields plumbed new lows as a political crisis in the Netherlands stoked investor fears euro zone commitments to contain the debt crisis were at risk.

The premium investors demand to hold Dutch rather than German debt surged to its highest in three years, and was expected to widen, after the Dutch government failed to agree budget cuts and offered to resign..

“Holland has always been seen as a safe haven, but it’s no longer Bunds in disguise but with a higher yield,” a trader said, adding longer-term investors and “fast-money” accounts had steadily sold Dutch bonds.

“Investors keep getting these scares but the money has to stay in Europe so it has to go into Bunds. So Bunds can keep going up.”

Data showing the euro zone’s private sector shrank faster than expected in April added to the malaise, piling pressure on the region’s fragile debt and pushing German Bund yields to record lows as investors sought safety in highly liquid low-risk bonds.

June Bund futures settled 97 ticks higher at 141.29, having risen as high as 141.37. German 10-year yields were 6 bps lower at 1.56 percent, off a low of 1.549 percent.

Traders and strategists saw little respite for non-German debt in coming days with investors also worried Socialist Francois Hollande - who won the first round of France’s presidential poll on Sunday - might loosen his country’s commitment to austerity.

The Netherlands will sell up to 2.5 billion euros of two- and 25-year bonds on Tuesday but analysts said the small size of the sale should meant there should be adequate demand.

“The Dutch thing has just come as a bit of a shock which people need to take on board,” said David Keeble, global head of rates at Credit Agricole. “We’ve seen some clients coming in and buying on today’s widening and the auction size is too small to be really worried about for now.”

Dutch 10-year yields were up 12 bps at 2.43 percent, pushing their spread over Bunds to 78 bps, the widest since April 2009, according to Reuters data. Some in the market were concerned the country could lose its triple-A credit rating if it failed to meet budget targets.

The cost of insuring against a default jumped to its highest since mid-December.

“Until we see a new coalition cobbled together in Holland and signs they are going to take action to cut the budget deficit over the medium term, investors are going to be nervous over Dutch bonds,” RIA Capital Markets strategist Nick Stamenkovic said.

French bonds held up better, with 10-year yields just a basis point higher before large cash inflows of around 35 billion euros from bond coupon and redemption payments on Wednesday.

However, Bunds’ outperformance saw the spread between 10-year French and German bonds widen to 155 bps and Stamenkovic said it could expand to 180 bps before a May 6 presidential runoff which Hollande is tipped to win.

There was no let up for the euro zone’s lower rated issuers. Spain, the latest focus of the debt crisis saw 10-year yields top 6 percent for the second session running.

A sustained break of that level could see borrowing costs accelerate to unaffordable levels that drove Greece, Ireland and Portugal to seek international bailouts.

The uncertainty in the Netherlands, a leading proponent of budget discipline in the euro zone, prompted Rabobank strategists to switch out of the 10-year Dutch bond leg of their buy Dutch, sell French debt trade and into July 2022 Bunds.

They entered the new trade at a yield spread of 129.5 bps over Bunds, citing expectations crisis tensions would deepen.

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