Spanish government bonds came under pressure on Friday after Fitch slashed Spain's credit rating, further hurting the prospects of a country edging closer to seeking financial help. European Union and German sources told Reuters that Madrid was expected to request aid for its ailing banks this weekend and euro zone finance ministers would discuss details on Saturday.
A government spokeswoman said she was not aware of any pending announcement on a bank rescue, but markets were expectant and looking out for the fine print. The impact of any such bailout on the market will depend on the way it is conducted, its size and whether it depletes regional funding for dealing with Italy if contagion spreads, analysts said.
"If we are making progress towards some sort of bailout for Spain, why is the market not reacting a bit more positively?" John Davies, fixed income at WestLB said. The reason: there was still too much uncertainty. "It's not just bailout or not for Spain, it's in what way? In what form? How much? Banks? Government? What's left over in the (euro zone) firewall?"
Spanish government bond yields rose 12.5 basis points to 6.24 percent, after falling this week as sentiment towards risk improved on lofty hopes of near-term monetary stimulus. Italian yields also gained 6 bps on the day to 5.77 percent, with markets uncertain about the implication of a Spanish bailout for the euro zone's third largest economy. Against a volatile backdrop, Italy sells bonds next week.
Against this backdrop, investors favoured relatively safe German bonds, taking Bund futures as far as 144.18 compared to a recent contract high of 145.97. It settled up 47 ticks on the day at 143.53. Barring surprise policy announcements, market tensions are likely to increase further next week, and German debt could again stand to benefit.