Germany’s Real Bond Yields Are Caught in a Downward Spiral

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After falling to within a whisker of this year’s lows, German inflation-adjusted bond yields look set to drop further on a rare mix of economic optimism and expectations for monetary easing.

Progress made toward coronavirus vaccines could boost the prospect of an economic rebound, spurring consumer-price increases and further eroding real yields, according to Commerzbank AG.

Also, the European Central Bank is seen keeping interest rates low and unveiling more policy easing next month -- which would weigh on debt rates -- to aid large-scale ongoing fiscal spending in Europe, said Christoph Rieger, head of fixed-rate strategy at the bank.

Germany’s Real Bond Yields Are Caught in a Downward Spiral

Governments from Germany to Italy are borrowing record amounts this year as they step up spending to counter the economic damage from the coronavirus pandemic. In addition, the European Union has started joint debt issuance in a landmark move aimed at supporting the region’s weaker economies.

“We could see more downside as expectations build up ahead of the December ECB meeting,” said Rieger. “Vaccine hopes keep inflation break-evens more elevated while central bank hopes keep a lid on nominal yields. Extremely low real yields are a pre-requisite to survive this massive build-up of debt. If real yields were to rise noticeably, it would be game over.”

German 10-year breakeven rates –- a market-based gauge of expected inflation -- climbed 15 basis points this month to 0.85%, on track for the biggest monthly increase since July 2019. Similar-maturity nominal bond yields are at minus 0.57%, below the ECB’s deposit rate and close to a two-week low.

While Germany’s 10-year real yield has slumped as low as minus 1.48%, the comparable U.S. rate has rebounded by 24 basis points from last quarter’s record low to minus 0.89%. The pickup in the American measure follows a policy shift in September by the Federal Reserve to a new plan that aims for inflation to average 2% over time.

©2020 Bloomberg L.P.

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