Bunds Lead EZ Bond Yields Lower

Germany led euro zone bond yields lower on Monday after fears that major oil producers could fail to agree an output cut at a meeting this week hurt oil prices, tempering the inflation trade that has driven bond markets since the U.S. elections.

The benchmark 10-year Bund yield fell to 0.2 percent , its lowest level since the U.S. election results on Nov. 9 sparked a bond market selloff, while two-year German yields hit a new record low at minus 0.76 percent.

The bond-market rally offered a respite to battered Italian bonds even as jitters about a looming referendum knocked banking stocks to an eight-week low, with focus for now shifting to the first of a series of upcoming risk events – Wednesday’s meeting of the Organization of the Petroleum Exporting Countries (OPEC).

The dim prospect of major oil producers being able to agree to output cuts aimed at reining in global oversupply at the meeting has unnerved oil markets. Oil prices slid 3 percent on Friday and a further 2 percent on Monday before they recovered some ground.

The prospect of reduced upward pressure on inflation from oil prices brought some relief to bond markets, which have been rattled by an expectation that the economic policies of U.S. president-elect Donald Trump will push up inflation.

“If OPEC fails to give oil prices a boost this week, that will pour some cold water on the ‘Trumpflation’ trade that has continued to drive overall bond markets,” said Commerzbank rates strategist David Schnautz.

A market measure of euro zone inflation expectations, the five-year, five-year breakeven forward fell below 1.60 percent – down from recent 10-month highs above 1.63 percent.

Euro zone bond yields were 1-4 basis points lower on the day. With German Bund yields leading the way, the gap against other euro zone peers touched new highs.

The yield spread between French and German 10-year bonds, for instance, was at its widest since March 2014 at 56 bps.

Spain’s yield gap with Germany was at its widest since June at about 138 bps, while the Dutch/German yield spread was at levels last seen in July.

Italian bond yields were dragged lower by its peers, but remained an underperformer as Italian stocks fell more than 1.5 percent.

Jitters before an Italian referendum on constitutional change this Sunday have undermined sentiment towards Italian assets, with bank shares and government bonds under pressure in recent weeks.

Italy’s bank index continued its decline on Monday, touching an eight-week low, while the yield gap with German Bunds hovered near 190 bps – its widest since 2014.

“There will be nervousness going into the referendum, but the market has already discounted a lot,” said Piet Lammens, a strategist at KBC.

French government bonds meanwhile drew some support from a resounding victory for Francois Fillon in France’s conservative primaries on Sunday, making him the favourite to win a presidential election five months from now against the far-right and a deeply divided left.

But with the result largely priced into markets after a strong showing for Fillon in the first round of voting a week ago, analysts said the market impact was limited.

Reuters

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell