The Poisonous Cocktail Stalking Negative Yield Bunds

By Mehreen Khan at The Telegraph

Investors have been warned of dangers of holding German government debt, as unprecedented central bank easing sends the country’s 10-year borrowing costs towards zero.

Germany bunds with a maturity of up to eight years have already veered into negative territory, and are likely to be joined by the country’s 10-year debt, which is currently trading at 0.15pc, down from 0.54pc at the start of the year.

A €1.1 trillion quantitative easing blitz from the European Central Bank last month has driven up the price of safe assets such as eurozone government debt. Yields, which move in the opposite direction to fixed income prices, have plummeted.

Anxiety over Greece’s future in the eurozone and the spectre of a deflationary spiral gripping the currency zone have also driven investors to seek shelter in high-quality sovereign debt. Germany’s triple-A rated sovereign paper is considered the safest asset class in the Eurozone.

But analysts are warning the market for the government debt is now becoming dangerously mispriced.

German bonds are vulnerable to a “potentially poisonous cocktail of resurgent inflation and wage increases,” according to David Roberts of Kames Capital.

“If you look at bunds in anything other than the shortest possible timescale, the risk becomes very clear,” said Mr Roberts.

Strategists at Bank of America Merril Lynch also warn that a “swift rise in German bund yields” would burn many investors.

“We think bund yields look mispriced given the strong German real estate market, strong economy and jump in inflation expectations,” said BoAML.

Switzerland, which is outside the currency bloc, became the first ever sovereign to sell its 10-year paper at a negative yield last week.

The Swiss auctioned €232.5m of debt at a yield of -0.055pc, meaning investors could end up paying Switzerland’s government to invest in its debt if they hold the securities to maturity.

More than half of all outstanding German government debt with a maturity of over 12-months trades at yields below zero, according to Citigroup.

“We think the need to look for yieldier assets will become increasingly more acute if we continue to see core government bond yields stay so low or fall even further,” said analysts at Deutsche Bank.

The race into negative territory could also worry the ECB, which has limited its bond-buying programme to exclude debt that yields less than -0.2pc. This currently exempts German short-term debt up to a 3-year maturity and highlights the dearth of quality assets available for the ECB to purchase.

“The ECB’s large-scale asset purchases are draining liquidity from sovereign bond markets,” warned Robert Kuenzel, at Daiwa Capital Markets.

But in a sign that low yields may not become a permanent feature of the global economy, Italy’s borrowing costs rose for the first time this year. An auction of seven-year paper saw yields rise to 1.35pc on Monday.

Divergent monetary policy between the ECB and the US Federal Reserve has also resulted in eurozone debt pulling away from US Treasuries.

How Germany’s 10-year bonds compare

However, the ECB now forecasts it will come close to hitting its 2pc inflation target by 2017, according governing council member Yves Mensch.

Evidence of a fledgling recovery across the monetary bloc has raised concerns that the ECB could pull the plug on QE before its stated September 2016 end date.

President Mario Draghi is expected to reassure markets the QE taps won’t be turned off prematurely at his latest monthly press conference on Wednesday.

How German government debt just got dangerous – Telegraph.