The short respite brought to euro zone bond markets by the European Central Bank's liquidity-boosting measures has ended, and the central bank will need to resort to more tricks in order to prevent yields from rising to unsustainable levels again, according to analysts.
Travelpix Ltd | Photographer's Choice | Getty Images
European Central Bank
With yields on 10-year Spanish bonds rising back to 6 percent for the first time this year on Monday, investors are turning their attention back to the fundamental problems plaguing the currency union, and some are again talking about its disintegration.
"I think it's basically the markets are now really bearish on Spanish and Italian debt," Eimear Daly, FX market analyst, Schneider Foreign Exchange, told CNBC.com.
"Spain is basically hostage to bond investors. What all the yields are showing is that the markets think that if someone needs a bailout, it will be Spain," she added.
The fear is that Spain will not be able to finance itself for long at these yields.
"If we have a situation where ten year Spain [bond yield] stays in a range of six to seven percent for 6-12 months, I think that raises a very serious question as to whether Spain would have to go to the ESM (European Stability Mechanism bailout fund) to re-finance," Bob Parker, senior advisor at Credit Suisse, told CNBC's"Worldwide Exchange".
Analysts at Capital Economics wrote in a research note that the markets are penalizing Spain "for not sticking to its fiscal consolidation plan." But even as Spain does take steps to impose more austerity, Spanish bond yields rise because of fears that this will plunge the country into recession again.
Contagion Fears
Contagion fears are still high, even though, as Capital Economics analysts say, markets "continue to give Italy the benefit of the doubt." However, they noted that the country is already back in recession and the ECB is still "unwilling to bring the crisis to an end by purchasing vast amounts of government debt".
Elsewhere, Ireland fell back into recession, putting a dent in its image of "poster boy" for how to save a country from the debt crisis; Portugal, despite its progress on cutting its budget deficit, faces structural problems this year, with labor reforms particularly unpopular, and the smaller countries in the euro zone suffer by their association with the single currency, according to the Capital Economics analysts.
Following the spike in Spanish bond yields, the upcoming auctions of debt in the euro zone will be watched with even more eagerness than they have up until now.
On Tuesday, Spain sold 3.18 billion euros in 12-month and 18-month Treasury bills, higher than the planned 3 billion euros but yields rose compared with previous auctions.
The yield for the 12-month T-bill was 2.62 percent compared with 1.42 percent, while the yield for the 18-month paper was 3.11 percent, up from 1.71 percent in a previous auction.
Bid-to-cover ratios, however, were better with the 12-month seeing a 2.9 ratio from 2.1 at the last auction and the 18-month T-bill's ratio at 3.8 from 2.9 in the previous auction.
More importantly, on Thursday Spain will launch auctions for two-year and a 10-year bonds, which will be closely watched.
Also on Tuesday, Belgium holds auctions for three-month and 12-month debt, while on Wednesday Germany and the Netherlands will hold auctions. On Thursday, France will have four auctions of bonds with maturities between 18 months and six years.
ECB to the Rescue
Unless the ECB intervenes in the markets, the debt crisis will worsen again, analysts warn.
"I'd say we're going to see a more acute phase of this crisis towards the middle of the year. It started already and it's going to perpetuate more," Schneider's Daly said.
She said the ECB would have to forget for a while about its role of fighting inflation and intervene either by using its Securities Markets Program (under which it buys government bonds on the secondary markets) or by lowering its interest rate, which at 1 percent is still the highest in the developed world.
But paymaster Germany fiercely opposes any more intervention from the ECB, with many officials and analysts in Germany arguing that the central bank has exceeded its mandate even with the measures it has taken so far.
"With a new fiscal pact and permanent crisis management mechanism in place as of the middle of this year, it is now up to governments to engineer a more symmetrical adjustment of fiscal accounts and bank balance sheets," according to Thomas Mayer, an analyst with Deutsche Bank.
Mayer wrote a research note arguing that the ECB's non-standard monetary policy measures – such as bond-buying and the long-term refinancing operations (LTROs) – were taken "to deal with problems in the financial sector and not to extend monetary policy easing beyond interest rate cuts, as was the case in the U.S. and UK."
But others disagree, arguing that ECB intervention would actually benefit Germany.
"I think more and more, Germany is becoming isolated," Daly said. "If yields continue to rise, something has to be done. If Spain needs a bailout, it's Germany who will have to pay."
