Investors to Look Beyond ECB Letdown as Yield Rally Offers Value

  • German 10-year yield jumped by most since 2011 on Thursday
  • Yields exceed analysts' year-end forecast by most since June

Don’t write off European bonds just yet.

German yields surged by the most since 2011 on Thursday after European Central Bank President Mario Draghi surprised the market by underwhelming their expectations on stimulus. The selloff pushed the nation’s 10-year yields to the highest relative to analysts’ year-end forecasts since July, after the ECB’s decision to cut its deposit rate by 10 basis points and extend the length of its bond-buying program was deemed by the market as inconsistent with Draghi’s pledge to “do what we must” to boost inflation. 

Even so, with stimulus still set to continue for longer, and the inflation and growth outlook remaining subdued, buying will probably set in again soon, according to Commerzbank AG, the top-rated primary dealer of German debt. Europe’s inflation outlook was dealt a blow on Friday as OPEC’s decision to set a record output ceiling sent oil tumbling, while a report on Dec. 8 is predicted to show the euro region’s economy expanded at a slower pace in the third quarter.

“The ECB’s package is fine and is underscoring the fact that the policy is still expansionary,” said David Schnautz, rates strategist at Commerzbank AG in London. “This should be supportive for bonds. The big thing about Thursday was the significant falling-short-of expectation component.”

The 10-year bund yield rose 22 basis points, or 0.22 percentage point, this week to 0.68 percent as of the 5 p.m. London close on Friday. That’s the biggest increase since the week ending June 5. The price of the 1 percent security maturing in August 2025 fell 2.11 or 21.10 euros per 1,000-euro ($1,089) face amount, to 103.005.

The nation’s two-year note yield rose 11 basis points to minus 0.30 percent. It had dropped to minus 0.454 percent before the ECB’s decision, the lowest since Bloomberg began compiling the data in 1990.

Optimism Damped

The optimism of bond bulls was damped only days after many had increased their bets following Draghi’s promise to “do what we must” to accelerate inflation. The ECB extended its quantitative-easing plan to at least March 2017 and expanded the range of assets it can purchase, while keeping the pace of monthly buying steady at 60 billion euros. Two-thirds of economists in a Bloomberg survey had predicted an increase in the level of purchases. The central bank reduced its deposit rate to minus 0.3 percent, defying some predictions of a cut to as low as minus 0.45 percent.

“To me, Draghi did the right thing,” said Fabrizio Fiorini, the chief investment officer at Aletti Gestielle SGR SpA in Milan. “He is no slave of the market. Like long-term investors, I’m very happy. The ECB is maintaining the road map to sustainable recovery. Bond prices should recover from these levels.”

European bond investors have had a rocky ride in 2015. When ECB officials started their asset-purchase plan in March, yields dropped to records, only to rebound the following month as investors including Janus Capital’s Bill Gross and DoubleLine Capital LP’s Jeffrey Gundlach discussed betting against the move. Yields then tumbled to new lows in the run-up to Thursday’s ECB policy meeting after Draghi’s pledge in October to reexamine stimulus.

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