European Long Bonds Are Near Their Sell-By Date

Something is stirring in the long grass of European bond markets and it doesn't bode well. Thirty-year French yields are the highest since the euro crisis in 2011, with Germany’s a hair from those dizzying levels. Investors are suddenly a lot less interested in buying extended maturities, which is bound to sharpen the pronounced fiscal pinch that governments are feeling.

The most recent catalyst for higher long-maturity yields in Europe was a Financial Times article last week about possible selling from Dutch pension funds next year. As Jefferies Financial Group Inc. Chief European Strategist Mohit Kumar highlighted, it’s not new information and it’s been well telegraphed, but bond vigilantes are alert for signs of fiscal deterioration.

As in the UK, the Dutch pension fund system is moving from a corporate final salary to an individually managed contribution set-up. That means liabilities will no longer behave like a long-dated bond. So Dutch pension funds, which invest heavily in German, French and other markets, will likely reduce their holdings to the 10-year from the 30-year part of the euro sovereign curve, along with broader allocation into equities and alternatives.

This is likely to apply further steepening pressure, especially as other investors follow suit. The benchmark German yield curve has steepened by 125 basis points this year, with money-market yields falling on European Central Bank rate cuts but those on longer-dated bonds rising by as much as 60 basis points. The 30-year German bund level climbed above 3.25% on Monday, with France’s at 4.2%.

This sharp steepening is all the more concerning as the ECB is hardly slacking, having halved its deposit rate to 2% over the past year. With euro area inflation forecast to fall further below target, more cuts are likely coming. Evidently the bond market’s concerns are greater than anything conventional monetary policy can resolve.