- Swaps indicate a 10 bps deposit-rate cut is fully priced in
- Bonds tumbled Dec. 3 even as ECB cut the rate as expected
European government bonds advanced as investors awaited the latest salvo in the European Central Bank’s attempt to reignite inflation in the euro region.
Germany’s 10-year bund yield fell from a three-week high as officials gathered in Frankfurt Thursday. Swaps indicate that a 10 basis-point cut to the ECB’s minus 0.3 percent deposit rate is fully priced in. Nearly three-quarters of the economists in a Bloomberg survey expect the ECB to expand monthly bond purchases.
While the anticipation of further easing pushed the bund yield to the lowest since April last week, the risk for investors is that there’s a repeat of what happened on Dec. 3, when bonds tumbled even as the ECB delivered a cut in the deposit rate that was in line with what was implied by swaps before the policy meeting. That day, Germany’s 10-year yield surged 20 basis points, the biggest increase since November 2011.
“At the very least, they’ll cut the deposit rate by 10 basis points if not a bit more and they’ll probably expand QE a bit further,” said Nick Stamenkovic, a fixed-income strategist at broker RIA Capital Markets Ltd. in Edinburgh. “I’m not convinced it’s going to have a significant impact on inflation expectations going forward and the risk is that, like December, the ECB could disappoint markets.”
Benchmark German 10-year bund yields declined two basis points, or 0.02 percentage point, to 0.22 percent as of 11:34 a.m. London time, after climbing earlier to 0.24 percent, the highest since Feb. 18. The 0.5 percent security due in February 2026 rose 0.17, or 1.70 euros per 1,000-euro ($1,097) face amount, to 102.715. The yield fell to 0.1 percent on Feb. 29, the lowest since April, the month it reached a record-low 0.049 percent.
Spanish 10-year bond yields dropped three basis points to 1.54 percent, while those on similar-maturity Italian debt declined two basis points to 1.39 percent.
Traders are pricing in a 80 percent chance that the ECB will cut the deposit rate to minus 0.4 percent, and 20 percent odds it’ll be lowered to minus 0.5 percent, according to data compiled by Bloomberg using swaps on the euro overnight index average. The calculation assumes the gap between Eonia rates and the deposit rate would remain in line with recent levels.
About $1.1 trillion of sovereign debt that meets maturity criteria for the ECB’s quantitative-easing plan yields less than its deposit rate, putting the securities out of reach of the program. A 10 basis-point cut to minus 0.4 percent would free up about $431 billion, according to the Bloomberg Eurozone Sovereign Bond Index, with 20 and 30 basis-point cuts bringing another $485 billion and $215 billion into play respectively.
Since the ECB started buying sovereign debt a year ago, German bonds have been the best performer among the 10 biggest eligible euro-region markets, according to Bloomberg World Bond Indexes. From the start of the program on March 9, 2015, German securities have gained 1.5 percent, while Portugal, which some analysts predicted would be the biggest winner under quantitative easing, has seen its debt lose 5 percent.