1. How low can they go? Germany sells 2-year debt after yield slide

How low can they go? Germany sells 2-year debt after yield slide

Germany will offer investors the chance to buy some of the most sought after assets in the euro zone on Tuesday, and in the process borrow cash for two years at record low rates.

By: | Published: February 28, 2017 4:43 PM
Germany, Peter Chatwell, European Central Bank, European Union, Donald Trump Germany’s two-year bond yield edged up slightly ahead of the auction to minus 0.92 percent but is within sight of last week’s trough of minus 0.96 percent. It is set for a fall of 23 basis points in February, its biggest monthly slide in 5-1/2-years.

Germany will offer investors the chance to buy some of the most sought after assets in the euro zone on Tuesday, and in the process borrow cash for two years at record low rates. The price of safe-haven Schatz bonds has rocketed over the past week on avid buying by Germany’s central bank and by private investors nervous about a possible euro zone collapse. The yield on outstanding two-year bonds – which moves inversely to price and is an indication of the rate at which a country can borrow on markets – hit a record low last week and is on track for its biggest monthly fall since 2011.

But analysts say that should not hurt demand for the five billion euros of new debt being auctioned at 0900 GMT as the central bank’s bond-buying scheme has created a drought in high-quality bonds and crimped short-term repo lending markets.

“We think demand could be boosted by the risk of a short squeeze in the issue in the first month of its life,” said Mizuho strategist Peter Chatwell. These bonds are not due to be sold again until late next month.

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“This is particularly true if the re-pricing of euro zone break-up risk continues to boost demand for short-dated German paper and if this demand spills over into the repo market.”

Germany’s two-year bond yield edged up slightly ahead of the auction to minus 0.92 percent but is within sight of last week’s trough of minus 0.96 percent. It is set for a fall of 23 basis points in February, its biggest monthly slide in 5-1/2-years.

Negative yields – often seen in the euro zone since the European Central Bank launched its quantitative easing (QE)scheme in early 2015 – mean investors are effectively paying for the privilege of lending to the German government.

While the national central banks administering the QE scheme were originally not permitted to buy bonds with a maturity below two years or with yields below the ECB’s deposit rate of minus 0.40 percent, changes to those rules in December have dragged down short-term yields.

Analysts say Germany’s Bundesbank, in particular, has been aggressively buying shorter-term bonds to make it easier to unwind the scheme which is scheduled to run until at least December 2017.

“The repeated record lows in two-year yields underscore that one buyer is more than enough with the Bundesbank’s aggressive utilisation of the sub-depo option,” Commerzbank strategists said. Some 14 billion euros of redemptions next week should also help demand, they said.

There are about 106 billion euros outstanding in two-year Schatz bonds, according to data from Germany’s debt office.

SPOOKED

Alongside central bank buying, private investors have been pouring money into this safe-haven debt because they are worried about the prospect of anti-euro, far-right leader Marine Le Pen winning May’s French presidential election run-off.

She trails centrist Emmanuel Macron in the polls by some margin, but bookmakers odds suggest a roughly 30 percent chance that the election result may surprise as did Britain’s vote to leave the EU and Donald Trump’s U.S. presidential election win.

Le Pen has pledged to take France out of the euro, just as eurosceptic movements in Italy and the Netherlands have also gained prominence. A survey on Tuesday showed one in four investors expect the bloc to lose a member in the next year.

Increased buying of shorter-dated German bonds – seen as one of the safest assets in the euro zone despite their high price – is contributing to an acute shortage of bonds for repos, or repurchase agreements.

Banks and big business rely on repo markets to raise cash against their bond holdings but recent volatility has led to a surge in funding costs and threatens the functioning of this market often viewed as the plumbing of the financial system.

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