Yield Hunters Still Face Germany Becoming ‘Sick Man’ of Europe

(Bloomberg) -- As goes Germany, so goes Europe. While euro-area manufacturing PMIs for August improved marginally, export orders are still poor and global politics poses major downside shocks.

• Bund yields are already reflective of increased recession risks and central banks’ inability to restore inflation
• Those need to resolve themselves somewhat for the decline in yields to abate
• A significant rebound would need either real signs of fiscal easing, de-escalation of trade wars or a Brexit deal
• The Euro Stoxx banks index is nearing an inflection point, and the cumulative adverse effects of the ECB’s negative deposit rate are part of the reason why euro-area banks are trading at a low price-to-book ratio

• The key problem is that banks can’t apply negative rates to retail deposits as clients would withdraw funds and hold cash; lenders ultimately need Euribor to move back into positive territory

ECB Will Find It Hard to Match Intent With Action on Banks’ Woes

• No one knows how low policy rates can go as the effective lower bound evolves and banks try to deal with the squeeze of their balance sheets (Eonia forwards pricing 35bp cuts of ECB depo-rate by end of 2020)
• Nations are bracing for a lower-for-longer environment in various ways: negative mortgage rates in Denmark highlight the squeeze on the left side of the balance sheet while Switzerland’s UBS plans to pass on the pain by reducing the threshold at which they charge on deposits
• Germany’s Christian Social Union is already trying to create a law that bans banks from passing negative rates on to retail clients holding up to 100,000 euros
• Banks’ worst fears are that the effective lower bound will keep moving lower and laws blocking ways they can pass on negative rates would leave them hedging structurally

• NOTE: Tanvir Sandhu is a global fixed income and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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