Bond rally pushes German short-term yields deeper below zero

Posted on November 22, 2016

European government bonds are rallying this morning, providing pause in a sustained sell-off driven by prospects of rising US inflation and insurgent populist movements in Europe.

Germany’s benchmark 10-year Bund yield has slipped four basis points this morning to 0.24 per cent, while the country’s five-year paper has fallen below the -0.4 per cent yield threshold that makes it eligible for European Central Bank bond purchases (yields fall when a bond’s price rises).

Tuesday’s session snaps a six-day losing streak for the eurozone’s benchmark debt, with bonds buoyed by the announcement that Angela Merkel will seek a record fourth term as German chancellor.

Peripheral eurozone bonds, which have borne the brunt of the recent sell-off, are outperforming today. Italy’s 10-year yields are down 9.5 basis points, while equivalent maturity Portuguese debt is rallying 10 basis points to 3.6 per cent.

European bond prices have been dragged lower in light of the US presidential election, with fears Donald Trump’s election will embolden populist movements in France, Italy the Netherlands, Austria and Germany. All five countries are due to hold votes in the next 12 months.

Mr Trump’s victory has also has led investors to reassess their forecasts for inflation, predicting higher consumer prices on the back of rising government spending and tax cuts in the world’s largest economy.

Financial markets are now in the midst of a “important regime shift”, says Richard Turnhill at BlackRock, as investors look to diversify their portfolios in light of Mr Trump’s impending arrival in the White House.

He notes:

We favor shorter-term bonds whose returns are partly shielded from higher yields. We prefer value stocks, those that look relatively cheap on metrics such as book value and tend to perform well when bond yields rise.

Credit analysts at Deutsche Bank are forecasting higher bond spreads for the first time since the eurozone sovereign debt crisis but expect bond market gyrations to continue on an uncertain political outlook.

“Volatility will increase as the market swings between believing that fiscal spending will lead to higher growth, inflation and higher yields one moment to perhaps then believing that global central banks are likely to cap the rise in yields the next”, said Jim Reid at DB.

He adds in a more sombre note:

The global financial system remains broken and extremely fragile. Secular stagnation trends are everywhere. The world has too big a debt burden for the current growth environment. We still think helicopter money is inevitable at some point and you could argue we’re unofficially there already. Indeed if the BoJ maintains its commitment to defend zero 10-year JGB yields and President-elect Trump’s fiscal plans are at the more aggressive end of expectations then we effectively have cross border helicopter drops.

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