German Yields on Brink of ECB Deposit Rate Point to Lost Decade

(Bloomberg) -- Germany’s 10-year bond yields are threatening to drop below the European Central Bank’s deposit rate for the first time.

A surge in Europe’s safest and most liquid bond market has taken yields close to the minus 0.40% rate that the central bank pays on money parked with it. Analysts predict bunds will keep rallying on the conviction that Christine Lagarde, who is set to succeed Mario Draghi as ECB President, will increase stimulus through rate cuts or fresh quantitative easing. Goldman Sachs Group Inc. sees a slide in the benchmark yield to minus 0.55% by end-2019.

The move to more deeply negative yields supports the argument that Europe may be going through a process of “Japanification,” a world of permanently low interest rates and tepid inflation. It will likely spur a drive into riskier assets, such as Italian notes, which offer much higher yields but come with the prospect of dramatic selloffs should sentiment turn.

“The bund yield falling below the deposit rate will have investors questioning what value there is in the asset,” said Peter Chatwell, head of European rates strategy at Mizuho International Plc. “For an investor who truly sees value in 10-year bunds at -0.4% then I expect they will see greater value in 30-year bunds at 0.25%, for at least there is a positive yield to maturity.”

Ten-year German yields have fallen seven basis points this week to a record-low minus 0.39% on Wednesday. Euro-area bonds have surged across the board this year in a hunt for returns, with Italian two-year yields dropping below zero and 10-year securities in Belgium, France and the Netherlands already having joined a burgeoning global pile of negative-yielding debt.

In the U.K., Bank of England Governor Mark Carney has warned that a major policy response may be required to combat a “widespread slowdown.” U.S. investors meanwhile are awaiting a spate of data including June’s payroll figures that could help dictate the extent of the Federal Reserve’s policy loosening.

Scarce Bonds

The ECB can currently buy bonds that yield less than the deposit rate, though priority is given to those that still offer a premium. In Germany, there are scant securities left in that category, although President Draghi has hinted the ECB could tweak rules on the level of debt the institution can hold.

The central bank isn’t yet ready to rush into additional monetary stimulus at its meeting this month, and is leaning toward September to wait for more data on the economy, according to officials familiar with the matter. Any later could leave the decision to Lagarde, who has been nominated to succeed Draghi when his eight-year term ends on Oct. 31.

Lagarde, an early proponent of QE for the euro zone, would be well suited to be ECB President at a time when the central bank needs to implement more expansionary policies, according to Chris Hiorns, a fund manager at EdenTree Investment Management. Morgan Stanley said the choice of Lagarde increases its conviction that the ECB will eventually resume buying bonds.

Mirroring Japan

In any case, Goldman sees little room for the ECB to loosen policy conventionally, mirroring Japan’s long-standing troubles to revive inflation and growth. The bank expects the ECB to cut the deposit rate by 20 basis points and return to quantitative easing in September. Others have also rushed to predict new lows in bund yields, a turnaround from the start of the year when many analysts expected the ECB to tighten policy and yields to climb.

“Minus 0.4% for 10-year yields can still look good if you are expecting the ECB to soon cut rates to lower levels and to stay there,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG.

To contact the reporter on this story: John Ainger in London at jainger@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Neil Chatterjee

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