From Bloomberg:

Italian and Spanish bond yields surged to euro-era records while German bunds rallied as contagion from the sovereign-debt crisis spread, piling pressure on Europe’s leaders to find measures to contain the turmoil.

Yields on two-year Greek debt also reached the highest since the 17-nation single currency’s introduction, while benchmark bund yields sank within 12 basis points of an eight- month low. European Central Bank President Jean-Claude Trichet reiterated his opposition to Greek debt restructuring as euro- area leaders prepared to meet in Brussels on July 21. Stocks fell on concern European banks may need to raise as much as 80 billion euros ($113 billion) of capital following stress tests.

“It does not seem as if we are going to see an immediate solution to the debt crisis, so investors prefer to stay on the cautious side, and this is being reflected in German bunds,” said Kornelius Purps, a fixed-income strategist at UniCredit SpA in Munich. “There is no genuine reason to price Italy and Spain down. It’s general contagion. It’s an alarming signal to European leaders to come up with a solution that doesn’t create more contagion.”

Yields on 10-year Italian bonds increased 25 basis points to 6.021 percent as of 12:34 p.m. in London, surpassing last week’s 6.016 percent peak. That’s the highest level since 1997. The spread, or yield gap, over benchmark German bunds widened to 338 basis points. The 4.75 percent Italian security due September 2021 fell 1.76, or 17.60 euros per 1,000-euro face amount, to 91.22. Two-year Italian yields climbed 40 basis points to 4.62 percent.

Spanish Yields, Bunds

Spanish 10-year yields rose 26 basis points to 6.33 percent, taking the spread over bunds to 370 basis points. Greek two-year note yields surged 133 basis points to 34.40 percent, also a euro-era record.

The 10-year German bund yield declined six basis points to 2.64 percent, after reaching 2.62 percent. The yield fell to 2.50 percent on July 12, the least since Nov. 12. Yields on two- year notes declined three basis points to 1.18 percent, still higher than the 1.05 percent reached on July 12, which was the least since Jan. 13.

Yields on notes from Italy, Ireland, Portugal and Greece soared last week, while German bunds advanced for the fifth time in six weeks as Europe’s politicians clashed over how to solve the crisis in the 17-nation euro region and craft a new rescue plan for Greece involving private bondholders.

Trichet told the Financial Times Deutschland in an interview published over the past weekend that Europe can surmount the crisis and that the euro remains “a highly credible currency.” He reiterated that the ECB will not accept bonds from a nation that defaults as collateral.

Stress Tests

“In the eyes of the Governing Council, this would impair our ability to be an anchor of confidence and stability,” Trichet said, according to a transcript of the interview released yesterday by the Frankfurt-based ECB.

The MSCI Asia Pacific Index declined 0.4 percent, while the Stoxx Europe 600 Index was 1.2 percent weaker. Treasuries advanced, while the euro fell the most in almost a week against the dollar, shedding 1 percent.

The eight banks that failed stress tests among 90 that were assessed by the European Banking Authority have a combined capital shortfall of 2.5 billion euros, the regulator said in a July 15 report.

As many as 20 banks need to bolster capital by as much as 80 billion euros, JPMorgan Cazenove analysts led by Kian Abouhossein wrote in a research note after the tests’ release.

The cost of insuring against default on European sovereign debt, including bonds sold by Greece, Ireland, Italy, Portugal and France, rose to records, according to traders of credit- default swaps. Contracts on Greece jumped 45 basis points to 2,460, Ireland climbed 24 basis points to 1,158, Italy increased 15 to 321, and Portugal rose 24 to 1,170, CMA prices showed.

Default Swaps

Swaps on France soared six basis points to 120 and Germany climbed four points to 64, the highest since March 2009.

“As long as sentiment remains doubtful, then there is a risk of further spread-widening,” Purps said. “If sentiment improves then there is potential for massive spread-tightening, particularly in Spain and Italy, but also in the other European countries, like France, where spreads have been widening.”

Markets were further roiled by U.S. President Barack Obama’s July 15 admission that rival Republicans and Democrats are “running out of time” to resolve an impasse on how to balance the federal budget and raise the $14.3 trillion debt ceiling before an Aug. 2 deadline.

Standard & Poor’s warned last week that there’s at least a 50 percent chance it will cut the U.S.’s AAA rating by one or two notches into the AA category within 90 days should the nation’s politicians fail to agree on how to lower the deficit.

German government bonds have handed investors 2.2 percent this year, while U.S. Treasuries have returned 3.7 percent, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italian bonds have lost 3.2 percent, while Spain’s have declined 0.3 percent, the indexes show.

--With assistance from Gavin Finch and Abigail Moses in London. Editors: Keith Campbell, Matthew Brown.

To contact the reporter on this story: Garth Theunissen in London gtheunissen@bloomberg.net; Emma Charlton in London at echarlton1@bloomberg.net.

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net.

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