The quick move higher in the yields of Europe's weakest sovereigns from historic lows may be just the beginning and on the edges it could start to affect other low-rated credits where investors have hunted for yield—such as U.S. junk bonds.
Driven by speculation about the European Central Bank and selling by major investors, the prices of peripheral European bonds have been weakening since last week. As a result, the yields of sovereigns—Spain, Italy, Greece, Portugal and Ireland—have all moved higher, while the core German bund yield has edged just slightly higher.
The 10-year Spanish bond, for instance, was yielding 3.008 percent Tuesday, after reaching a low of 2.832 percent last Thursday, its lowest level in 20 years. As investors sell, Greece's 10-year yield is creeping back toward 7 percent, after making a four-year low of 5.85 percent in April.
"I think this has more room to go. It's been about a year in the making. We've barely seen much of it yet," said Marc Chandler, chief currency strategist at Brown Brothers Harriman. "Some large funds like BlackRock have indicated they are beginning to take profits on it. Then the EU and IMF expressed concern that those bond market rallies were not going to be sustainable."
Trader chatter has increased about the fact the selloff in Europe could lead to more caution about risk exposure in other areas of global fixed-income markets.
"While there's not been wholesale selling and aggregate index performance has turned in solid results, underlying trends suggest a consolidation in risk exposure," said Adrian Miller, director fixed-income strategy at GMP Securities.
Miller said he studied month-to-date performance in the high-yield market. "Two-thirds of the names have underperformed. That speaks to breadth," he said. "Obviously people are not running from U.S. high yield. It's still getting inflows, but there is that general overtone and questions of valuation that are running through the market."
He said, however, there is a more marked weakening in the European high-yield market. "There are obviously degrees of magnitude, but the concerns about risk exposure are really showing up in Europe right now and emerging markets as well," Miller said.
Steven Antczak, head of U.S. credit strategy, said he believes the weakening of some U.S. high- yield issues is more about fundamentals at specific issuers.
"I think the typical PM is less inclined to react to something that is very exogenous," he said. "The typical PM is more inclined to move to neutral than short the market or sell it off. I think the reaction will be to sit and wait and see."
The selloff started at the same time U.S. rates moved dramatically lower, with the U.S. 10-year yield dipping below 2.5 percent last week for the first time since July and the largest weekly drop in yield since early January. Investors had piled into short positions on expectations the Federal Reserve's move to taper back its quantitative easing bond purchases would push yields higher.
"One thing that I think has been driving the move in the periphery is the flip side of what's been driving the move in U.S. Treasurys," said Ralf Preusser, head of European rate research at Bank of America Merrill Lynch.
Preusser said managers that were betting on higher rates were underweight duration, but rates moved lower this year. The U.S. 10-year ended last year with a 3 percent yield and has not been as high since.
"They were overweight the periphery against their core duration short," he said. "The move that we saw last week in particular caused a lot of people to close out their duration shorts and the flip side of that has been a long in the periphery. in the U.S., the expression of the periphery long in Europe has been an overweight in credit."
The European yields have also been rising because of doubts that the European Central Bank will embark on a quantitative easing program, as some investors had expected.
ECB President Mario Draghi's comments after the last ECB meeting have led the market to believe the ECB will take some action when it meets June 5. Preusser expects the ECB to cut its refi and deposit rate and announce a program to purchase.
"I think in the periphery the risk is between now and the ECB meeting, we continue to see profit taking...and I think the risk is we do move higher or at least fail to grind tighter from here," Preusser said.
But it will be what the ECB foreshadows that will be possibly even more important to the markets. Preusser said the market is hoping to hear under what conditions the ECB could launch QE and what it would look like.
"After the ECB meeting, it's really a question of whether the ECB meets exuberant market expectations," he said. "Really what will set the tone for the markets after the ECB meeting is what Draghi tells us…I don't think they will give us enough details to sustain the market expectations."
U.S. high-yield debt has also tightened, and the lowest quality credits are drawing in investors hungry for yield, driving prices higher and yields to extreme lows.
Preusser said a lack of volatility in the interest rate market is one reason low-rated credits look appealing.
"The volatility adjusted return just looks incredibly high and benchmark investors models will continually flag the periphery up as being much better investment than core government bond just because the vol is so low," he said.
In a note, he pointed out that the peripheral debt selloff could be a canary in a coal mine.
He said they trade in line with their ratings and when viewing spreads on a relative rather than absolute basis, the periphery is at the cheapest levels year-to-date after the selloff.
Preusser said it will be very difficult for the periphery to sell off in isolation, and at current yield levels in German bunds and Treasurys. He said he expects demand for the periphery to re-emerge, but he noted he would not be a big buyer ahead of European parliament elections and before the ECB meeting where investors could be disappointed.
—By CNBC's Patti Domm.