German key return above 0% again. Here’s what it means

0

LONDON, Jan 19 (Reuters) – Bond markets have just passed a major milestone – German 10-year bond yields have shot above 0% for the first time in almost three years, potentially marking a return to more normal credit conditions in Europe.

Negative bond yields in Germany, the eurozone’s benchmark issuer, are the result of aggressive asset purchases by the European Central Bank, which has been used to lift inflation that has been below its target for years. Therefore, the rise in Bund yields up to 0.025% on Wednesday is significant.

“It clarifies the message that yields are on the way up and that the era of ‘longer low’ is over,” said Antoine Bouvet, Senior Rate Strategist at ING.

Sign up now for FREE unlimited access to Reuters.com

to register

The German Bund yield is positive again for the first time since 2019

1/ INFLATION Beast AWAKENS

Eurozone inflation is at a record high of 5%, well above the ECB’s 2% target, and the economy is recovering from the COVID-19 pandemic, so ultra-low yields no longer seem justified.

Wednesday’s data, which showed UK inflation at its highest level in almost 30 years, reiterated that price growth is proving sluggish across the board.

Bund yields are up 40 basis points in the past month alone, a very different environment from 2016 when the ECB expanded asset purchases to fight deflation and pushed 10-year yields below 0% for the first time.

Eurozone inflation at record high

2/ SO LONG FRIEND

One driver pushing up Germany’s borrowing costs is US Treasury yields, which have risen sharply on expectations that the Federal Reserve could start raising interest rates in March and even attempt to downsize its $8 trillion-plus balance sheet are.

The ECB’s €1.85 trillion pandemic bond-buying program expires in March and money markets are pricing in two euro-zone interest rate hikes before the end of the year, although the ECB insists that price growth will moderate on its own by the end of this year.

The ECB will remain present in bond markets, but for the first time since 2019, the net supply of bonds issued by eurozone governments is expected to exceed ECB purchases this year. Continue reading

Supply Outlook from BofA

3/ YIELD HUNTERS BEWARE

Low yields in Germany and other high-quality issuers have long pushed investors into riskier assets such as equities, junk-rated bonds and debt from weaker countries like Italy.

Bunds at just 0% will not change that picture immediately, but further increases could reduce the attractiveness of such assets. The tightening of monetary policy is already increasing the risk premiums of heavily indebted southern European countries and companies.

However, many argue that with inflation-adjusted returns still deeply negative, investors will continue to seek riskier assets. That explains why stocks are near record highs despite rising government bond yields. Continue reading

“With a gradual, orderly sell-off on the back of improving macroeconomic fundamentals and a positive risk backdrop, I don’t think that’s such a big issue,” said UBS strategist Rohan Khanna.

Italian and junk bond yield spreads

4/ SHRINKING POOL

Germany has nearly $2 trillion in outstanding debt, with 10-year bonds accounting for about 40% of issuance. Yields above 0% will therefore significantly reduce the bond pool with negative yields.

According to the Bloomberg Global Aggregate Negative Yielding Debt Index, as of the end of 2020, up to $18 trillion worth of negative yielding debt was being traded around the world. Now that pool has dwindled to about $9 trillion.

Reuters graphics

Sub-zero yields mean that investors are paying the issuer to hold their debt. That’s good news for governments, but not for banks and investors like pension funds, which need higher yields to cover their long-term liabilities.

“It’s definitely being hailed as a step towards a more normal environment,” said Antonio Cavarero, head of investments at Generali Insurance Asset Management.

5/ HOW MUCH FURTHER?

It’s not a paradigm shift — most investment banks still expect Bund yields to be around or just above 0% by the end of 2022.

ECB projections still suggest inflation will average 3.2% this year and fall back below the bank’s 2% target in 2023. This suggests that the eurozone central bank, unlike its US or UK counterparts, will not hike rates immediately.

Sign up now for FREE unlimited access to Reuters.com

to register

Reporting by Dhara Ranasinghe and Yoruk Bahceli; Editing by Sujata Rao and Catherine Evans

Our standards: The Thomson Reuters Trust Principles.

Share.

Comments are closed.