Record-Low Borrowing Costs Leave Euro-Area Bondholders on Edge

June 26 (Bloomberg) -- Bloomberg's Scarlet Fu and Lisa Abramowicz examine the amount of money that has flowed into taxable bond funds since the financial crisis and how rising rates may impact the bond market rally. They speak in "On The Markets" on Bloomberg Television's "In The Loop."

After a six-month rally sent borrowing costs in the euro-area government bonds to an all-time low, investors say they are wary about boosting their holdings at the current level.

Euro-region bonds rose today, set for the longest run of monthly advances since the end of 2012, after the European Central Bank unveiled an unprecedented package of stimulus measures designed to boost the economy. That’s sent yields from the Netherlands to Ireland to record lows this month, while German 10-year borrowing costs are falling toward levels plumbed only at the height of the region’s debt crisis.

“The market seems to be somewhat stretched on the downside of yields,” said Michiel de Bruin, head of global rates at F&C Asset Management Plc in London, which manages about 83 billion pounds ($141 billion) globally. “While yields can go down a bit further still, we think on a medium-term basis they could go higher. Given the rally that we’ve seen, a lot of the news is priced into markets.”

The average yield to maturity on euro-area government bonds fell to an all-time low of 1.32 percent yesterday, according to Bank of America Merrill Lynch’s Euro Government Index.

The rate on Irish 10-year debt fell as much as three basis points to 2.327 percent today before closing at 2.33 percent as of 5 p.m. London time. The yield on similar-maturity Dutch bonds dropped to 1.478 percent, while Belgian 10-year yields slid to 1.685 percent. French and Spanish 10-year yields fell to records earlier this month.

Backstop Measures

Demand for the euro region’s higher-yielding assets surged this year as ECB stimulus put in place this month added to already-existing backstop measures to attract investors. While confidence in the durability of the region’s monetary union was restored after ECB President Mario Draghi vowed in July 2012 to safeguard the euro, inflation at about a quarter of the central bank’s target and near-record joblessness prompted the additional policy easing and sparked speculation of yet more.

Italy’s 10-year yield dropped one basis point, or 0.01 percentage point, to 2.85 percent before the nation sells 8 billion euros ($10.9 billion) of bonds, including debt due in September 2024, tomorrow.

“Bonds aren’t a sell here, but I just don’t think they are a buy,” said Marc Ostwald, a strategist at Monument Securities Ltd. in London. “It’s right to look at these levels and ask what the downside is in yield terms. The answer is not very much. That’s not to say they are going back up, and they may go a bit lower, but the question is do you want to chase it?”

Safest Debt

German securities, perceived to be among the safest government debt in the euro bloc, got an additional boost this week as political instability from Iraq to Ukraine and signs the U.S. economy was faltering spurred demand for the safest assets.

Ukraine isn’t “too optimistic” that it will soon reach a peace deal with separatist rebels, Economy Minister Pavlo Sheremeta said at a conference in Kiev today. Iraq Prime Minister Nouri al-Maliki is struggling to crush an al-Qaeda breakaway group in northern Iraq.

German securities also jumped with Treasuries yesterday as a report showed the U.S. economy contracted in the first quarter by the most in five years. Data today showed consumer spending grew less in May than analysts forecast.

Geopolitical Tensions

“The strong backdrop for bunds should persist near-term,” Alexander Aldinger, a fixed-income strategist at Commerzbank AG in Frankfurt, wrote in a client note today. “Geopolitical tensions and month-end index extension buying will further underpin bunds,” with yields approaching their all-time lows, Aldinger wrote.

The ECB may not have reached the lower bound on its key interest rates, Market News International reported, citing two euro-area officials without identifying them. The governing council was in no hurry to take further monetary policy decisions, Market News said. The central bank cut its refinancing rate to a record-low 0.15 percent on June 5 and started charging commercial lenders to park cash with it overnight.

German 10-year yields fell two basis points to 1.25 percent after touching 1.24 percent, the lowest level since May 2013 and within 12 basis points of the record-low 1.127 percent reached in June 2012.

Euro-area securities returned 7.1 percent this year through yesterday, Bloomberg World Bond Indexes show. The securities have gained about 1 percent this month, after climbing in each of the previous five.

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; David Goodman in London at dgoodman28@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net Mark McCord, Todd White

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