Investors showed a healthy appetite for Spanish debt Thursday but demanded a higher borrowing rate in an auction that was a key test of confidence in the government's ability to get a handle on its debts.
The Treasury auctioned (EURO)2.54 billion ($3.33 billion) in two- and 10-year bonds at the top end of targeted demand. It had set a range of (EURO)1.5 billion to (EURO)2.5 billion for the sale.
The interest rate, or yield, on the 10-year bond was 5.7 percent, up from 5.3 at the last auction on April 4. Demand was more than double the amount sold, down from about triple at the last auction.
However, on the secondary market later in the day, yields on the 10-year bonds shot up after starting the day with relative stability. In late afternoon trading, the 10-year Spanish yield was at 5.88 percent, up 0.06 percentage points for the day, according to financial data provider FactSet.
This was attributed in part to investors rushing to safer bets such as German bonds, which have seen their prices rising. Bond prices and yields move in opposition directions.
"The gap between the strong and weak is increasing. Investors are increasingly looking to lend or invest only in 'safe' countries. We're not yet at crisis point but much more bad economic or political news from the Iberian peninsula could tip us into the danger zone," wrote Louise Cooper, market analyst with BGC Partners in London.
The benchmark Ibex 35 stock index was down 2 percent, after losing nearly 4 percent on Wednesday.
"There's a lot of uncertainty about Europe, there were rumors throughout the morning of a possible downgrade of French debt, there are increasing doubts about the health of Europe's economy in general," said Alejandro Varela, an analyst with Renta4, a Madrid brokerage.
He said Spain is in the eye of the hurricane because of attention on its economic reforms and a big rise in banks' rate of bad loans. "It's true that Spain is doing its homework but it still remains a center of attention."
Over the past couple of weeks, investors have focused on Spain and whether its new conservative government can push through its austerity and reform program at a time of recession and sky-high unemployment.
Earlier this week, the yield on Spain's 10-year bonds on the secondary market, where they are traded like shares, spiked above 6 percent, toward the levels that forced Greece, Ireland and Portugal into seeking outside financial help.
The problem for the other 16 countries that use the euro, however, is that Spain's economy is about double the size of the three bailed-out countries, meaning that it will cost much more to bail out.
"Markets are becoming increasingly worried that, in the absence of a much bigger firewall than the one which is currently available, Spain will find itself in a similar situation to Greece, only without the luxury of a bailout to fall back on," said Michael Hewson, senior market analyst at CMC Markets.
Ciaran Giles contributed to this report.