Weak German debt sale is a 'disaster' for Europe

Traders in Frankfurt were feeling the blues on Wednesday after a disappointing bond auction lifted German 10-year yields above 2%.

NEW YORK (CNNMoney) -- European bond yields rose Wednesday after a German bond auction flopped, undermining trust in eurozone government debt.

"When you can't even draw good bids on German bonds, which everyone thinks is sacrosanct, you really do have a problem," said Kathy Jones, fixed income strategist at Charles Schwab. "It's fairly ominous. People are simply afraid to be in European sovereign bonds."

Wednesday's auction was "undersubscribed," with Germany selling only €3.6 billion worth of German 10-year bunds. The results suggest "that Germany is not immune to increasing risk aversion in the [eurozone] sovereign debt market," wrote Marc Chandler of Brown Brothers Harriman.

As a result, the yield of the most secure government debt in the eurozone crept above 2%.

Tommy Molloy, chief dealer at FX Solutions, called the auction a "fricking disaster."

"I don't think I've ever seen a worse auction out of Germany," said Molloy, who has been covering the bond market since the 1980s. "The eurozone looks like a sack of garbage right now. Even though Germany is the very best piece of paper in the eurozone, it's still in the eurozone."

Germany is the largest economy in Europe, followed by France, and is considered to be a stalwart pillar of the eurozone economy. Therefore, its bonds are consider the gold standard of sovereign debt, keeping its yields relatively low.

The contagion spread to France, where the 10-year bond yield rose to 3.69% at the close.

Italian 10-year bond yields also rose, to 6.97%, flirting with the 7% danger zone once again. Investors tend to get nervous when sovereign bond yields get close to 7%.

While 7% does not automatically trigger a bailout, it is the level that Ireland, Portugal and Greece exceeded before they got bailed out by their European neighbors.

Italy recently exceeded 7%, then dropped back below it. The Italian economy is the third largest in the eurozone and is therefore too big to bail out. The nation's future is uncertain if yields continue their ascent.

Eurobond 'solution' won't stick

Spanish bond yields traded at a similar level, closing at about 6.65%. Spain has a better debt-to-GDP ratio than Italy -- 60% compared to 119%. But its deficit is higher and its unemployment, of more than 20%, is astronomical.

And then there's Greece, where the 10-year bond yield closed at the sky-high level of 29%. The returns are high for Greek bondholders, but so is the risk of default.

Molloy said the disparity between European bond yields resembles the state of Europe 20 years ago, before the creation of the 17-member eurozone.

"Bond yields are behaving as if we do not have a single currency," he said. "Bond yields are behaving as if we have 17 different currencies in the eurozone."