Investors looking to bet against the euro zone's lower-rated states turned their fire on Italy on Friday, pushing bond yields to euro-era highs and igniting concerns about the long-term cost of financing the region's most indebted country.
As Italy bore the brunt of the market's negative outlook on euro zone's debt crisis, the flight into safe-haven assets was boosted by well below-forecast jobs data from the U.S. which wrongfooted the market and sent Bund futures soaring.
Ten-year Italian bond yields hit their highest since the launch of the euro at 5.38 percent as domestic political uncertainty and banking worries lit the touch paper on longer-term concerns about the under performance of the country's debt throughout the sovereign debt crisis.
"If you're looking to trade against the periphery there's very little liquidity anywhere else. Italy has more depth, and it has (bond) futures -- if you want to have a go, you can get in and then get out," a trader said.
"It's only going to get worse. Hedge funds went after it in a market that has got very little risk appetite. No one is prepared to oppose the flow."
Other peripheral euro zone bond yields continued to rise after a poor week, as continued uncertainty over how to solve Greece's immediate debt issues and wider contagion fears hit investors' appetite for risk.
Shares in Italian banks dropped sharply and trading in UniCredit SpA , Italy's biggest bank by assets, was briefly suspended for excessive losses. Sources told Reuters the country's banks had passed EU stress tests.
The prospect of Italian economy minister Giulio Tremonti resigning over internal squabbles in the centre-right government was also seen as a threat to the continued reform of the country's finances.
The creeping rise of Italian yields across the maturity curve drew the country's debt sustainability into focus. Italy has more than 1.5 trillion euros of government bonds outstanding, of which nearly 200 billion euros will expire and need to be refinanced next year.
"They can't continue to see higher borrowing costs. Italian debt is huge and it will make a difference," said Orlando Green, rates strategist at Credit Agricole in London.
"That will be feeding back into the Italian sovereign balance sheet which will look very ugly, very quickly and could easily get out of control."
The cost of insuring Italian debt against default hit 245 basis points, up 38 percent over the course of the week and second only to Portugal as the worst performer across all credit default swaps this week.
Italy must face the market pressure next week when it issues up to 7.75 billion euros of BTP bonds as part of its roughly 230 billion euros of planned issuance for the year.
