"It's almost a waiting game now until they seek a sovereign bailout," said Lyn Graham-Taylor, a fixed-income strategist at Rabobank in London. The regional bailout plan was "the straw that broke the camel's back," he said.
After taking on as much as $121 billion of bailout loans to aid banks, the government of Prime Minister Mariano Rajoy runs the risk that helping regions will push bond yields to unaffordable levels.
The Treasury has focused on shorter-dated bonds to avoid paying the highest yields, a strategy that is now being undermined as five-year rates rise as high as 10-year yields.
Spain's funding costs are too high for the country to refinance itself long term and the situation is "very unpleasant," Thomas Wieser, the head of a group of senior officials that prepares meetings of euro-area finance ministers, said Tuesday.
"I would hope for us, and for Spain, that the nervousness subsides over the summer and spreads come back significantly," he said in an interview on Austrian radio.
The prospect of more regional governments following Valencia in seeking aid pushed the cost of insuring Spanish debt to a record Monday. Spain and Italy reinstated a short-sale ban on stocks as bank shares plunged to record lows, bond yields rose, and the euro fell below its lifetime average against the dollar. People who sell short hope to profit by buying back the securities later at a lower price and returning them to the holder.
Regions such as Catalonia started losing access to capital markets in 2010, prompting some to sell securities known as patriot bonds to their citizens.
Economy Minister Luis De Guindos said in March that the central government was considering guaranteeing regions' debt issuance. Four months later, the government created a $24 billion bailout fund. Last week, Valencia became the first region to say it would tap the facility, prompting a surge in Spanish bond yields.
"Now that the markets are focusing on whether Spain needs a program that will require more than just support for the banks, adding the regions' debt to the central government's funding needs doesn't help at all," said Ricardo Santos, a European economist at BNP Paribas SA in London.