Stephen Foley: After a breather, bond traders test eurozone

Outlook Perhaps it was the surprise that European leaders had managed to come to an agreement at all, rather than kicking the can down the road. Perhaps it was the sheer incomprehensibility of aspects of the deal. For whatever reason, it has taken financial markets a rather long time to identify the holes in the new bailout plan for Greece, agreed last week.

Now, though, the bond vigilantes are back. Italian and Spanish interest rates were rising again yesterday towards the level that terrified EU leaders earlier this month. The immediate cause? Germany's Finance Minister, Wolfgang Schaüble, wrote his stern letter to Bundestag members telling them not to stoke panic by questioning the financial position of these big and pivotal eurozone countries.

The letter had a touch of the Lance-Corporal Jones of Dad's Army, and by stating the obvious – "It would be a mistake to think that the crisis of trust in the eurozone can be solved by a single summit" – Mr Schaüble seemed to set off the very reaction he was saying was unjustified. With Greece and now its neighbour Cyprus getting the credit rating downgrades implied by last week's deal, the markets remain in febrile state. And, unjustified or not, bond investors are no fools. We already know Deutsche Bank has slashed its holdings of Italian government debt by nearly 90 per cent since the start of the year. No one wants to be last out if there is a real run.

The important of Mr Schaüble's letter, of course, is that it highlights once again how the politics of even the latest bailout plan is tough for Germany. Opposition to a "transfer union" is more likely to grow than diminish over the long summer recess.

The most obvious hole in the latest bailout is the failure to increase funding to the European Financial Stability Facility. Such an increase will be needed for the EFSF to be able to fight the bond market, should it turn on Spain and Italy.

It looks as if traders are determined to test the eurozone's resolve sooner rather than later.