Bloomberg News

German Bund Record Shows All Is Not Right in Euro Area

July 29, 2014

Europe’s debt crisis is a fading memory, its most-indebted nations have never been able to borrow so cheaply and growth is returning, yet German bonds, a key gauge of economic malaise, are setting the sort of records usually reserved for times of turmoil.

Bunds have joined a rally that’s swept borrowing costs to record lows across the euro area. The last time their yields plumbed such levels was when the region was in the grip of a downturn that threatened the euro’s existence. That they’ve dropped further reflects concern that the European Central Bank’s plan to stave off deflation and boost growth can’t work without further stimulus.

“Yields are low and I suspect they will probably go lower as deflation remains a real risk given the growth and inflation outlook,” said Robin Marshall, director of fixed-income at Smith & Williamson Investment in London. “There is a strong perception in the market that the ECB will have to ease policy further.” Smith & Williamson manage the equivalent of $25 billion in assets.

At first glance, ECB President Mario Draghi’s efforts to save the region appear to have worked. His pledge at the height of the crisis in July 2012 to safeguard the euro with measures that may include the purchase of member nations’ bonds helped steer yields such as Spain’s to the lowest on record from the highest in the euro area. The caveat is that success hasn’t translated into faster consumer prices or jobs growth, prompting Draghi to delve further into his stimulus toolkit.

Benchmark Rates

Benchmark German 10-year yields fell three basis points, or 0.03 percentage point, to 1.12 percent at 4:43 p.m. London time after sliding to 1.109 percent, the least on record, according to data compiled by Bloomberg dating back to 1989. The 1.5 percent bund due May 2024 rose 0.265, or 2.65 euros per 1,000-euro ($1,341) face amount, to 103.505.

Rates on 10-year euro-area bonds from Scandinavia to Spain also slid to records with France’s declining to 1.502 percent and Italy’s dropping to 2.632 percent.

“Yields are going lower because the market expects the ECB to do more in the low-growth, low-inflation environment that we are in,” said Lyn Graham-Taylor, a fixed-income strategist at Rabobank International in London. “Month-end demand also helps. It’s a bit of a function of low inventories and everyone being careful about being short heading into month end.”

A short position is a bet an asset’s value will drop.

Previous Low

Germany’s previous record-low yield of 1.127 percent was set in June 2012 when the crisis escalated as Greece’s finances became unsustainable and the spiraling debts of Spain and Italy spurred investors to dump those nations’ bonds. Then, the yield spread with Spain’s 10-year bonds was 536 basis points, compared with 135 basis points today, threatening the stability of the currency bloc.

Euro-area inflation remained at 0.5 percent for a third month in July, according to the median forecast of economists in a Bloomberg survey before the July 31 release. That’s below the ECB’s goal of just under 2 percent. The unemployment rate remained at 11.6 percent in June, a separate survey shows before the data due the same day.

Gross domestic product in the region will underperform its U.S. counterpart by about 1.5 percentage points on average in the two years through 2016, according to economists’ predictions compiled by Bloomberg.

Analysts Surprised

The rally in German bonds this year has caught analysts by surprise. At the end of 2013, strategists were forecasting that Germany’s 10-year yield would rise to 2.28 percent by Dec. 31, from 1.93 percent at the time, according to data compiled by Bloomberg. The yield has instead dropped about 80 basis points this year.

Companies across the region are among the biggest winners in the rally. The average yield on investment-grade corporate bonds in euros has fallen 64 basis points this year to a record low of 1.44 percent, according to Bank of America Merrill Lynch index data.

Low borrowing costs allowed Carrefour SA, France’s largest retailer, to sell 1 billion euros of eight-year notes this month to yield 67 basis points more than the mid-swap rate compared with a spread of 80 basis points it offered for six-year securities a year earlier, according to data compiled by Bloomberg.

German securities returned 5.6 percent this year through yesterday, Bloomberg World Bond Indexes show. That compares with the average euro-area gain of 8.2 percent and 3.5 percent for Treasuries.

“Just when some people thought peripheral bonds have come a long way, there is further room to go,” said Luca Jellinek, head of European rates strategy at an investment bank unit of Credit Agricole SA in London. “ECB’s policy bias remains a key impetus for investors to buy these bonds.”

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net Mark McCord


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