Credit market nerves wear on Italy, Spain bonds as Fed hike nears

* First U.S (Other OTC: UBGXF - news) . rate rise since 2006 expected on Wednesday

* Jitters in periphery stem from corporate debt markets

* Energy companies seen vulnerable after oil slump (Updates prices)

By John Geddie

LONDON, Dec 15 (Reuters) - Investor (LSE: 0NC5.L - news) fears that the first interest rate rise from the United States in nearly a decade could trigger a spate of defaults in highly leveraged companies has started to erode confidence in some of Europe's lower-rated sovereign debt.

The gap (NYSE: GPS - news) between short-dated Italian and Spanish bond yields and benchmark German equivalents rose to its highest level in five months on Tuesday even with the European Central Bank buying billions of the bonds under its asset purchase scheme.

Strategists said the poor performance was due to a weakening appetite for risky investments before the widely expected hike from the Federal Reserve on Wednesday - a cautious approach that had roots in corporate credit markets.

"At times like this, when liquidity is very thin due to the pending FOMC decision, the correlation between asset classes has a tendency to rise significantly," said Peter Chatwell, head of European rates strategy at Mizuho.

"Thus the weakness in credit markets, which itself may also be a function of the FOMC, is apparent in euro sovereign spreads."

The U.S. high-yield market has been at the epicentre of concerns that a rate rise in the world's largest economy could spell danger for companies that have become used to borrowing mountains of debt with near zero percent interest.

Energy companies are particularly under the cosh with oil prices near the lowest levels seen since the height of the financial crisis.

SHARP END

On Monday, the widely traded iShares iBoxx $ High Yield Corporate Bond index - essentially a basket of junk debt - expanded its losses for the year to 12 percent. A competitor product, the SPDR Barclays High Yield Bond, expanded its losses for the year to 13.4 percent.

The European high-yield market has also been at the sharp end of concerns in credit markets. The iTraxx Crossover -- a measure of risk that is derived from the credit default swaps of 75 sub-investment grade companies -- has risen sharply to levels not seen since early October.

Greater preference for safe haven investments has taken its toll on investment grade corporate debt and even lower-rated sovereign debt.

Italian two-year yields rose 3 basis points to 0.17 percent on Tuesday and Spain's rose by a similar amount to 0.14 percent. Both edged away from German equivalents which were up slightly at -0.32 percent.

The gap between the peripheral bonds and Europe's benchmark is the widest it has been since July 10.

While longer-dated bond yields rose sharply across the board on Tuesday as a bounce in equities and the oil price roiled illiquid markets, evidence has been mounting of the gulf between peripheral and core euro zone bonds.

The gap between Italian and German 10-year yields is at its widest since mid October at around 105 bps.

Yet some fund managers remain uncertain whether credit market jitters spell trouble ahead for peripheral debt in 2016.

"On the one hand, if you saw a material rise in corporate bond defaults, you could expect spreads to be wider than they are today," said Mark Dowding, co-head of investment grade debt at BlueBay Asset Management.

"But if you are going into this world of rising defaults, all things being equal central banks will need to do more policy accommodation so actually it raises the prospect of the ECB needing to do more QE." (Editing by Estelle Shirbon)