Brexit fears drive German bond yields to below zero

14th June 2016, Comments 0 comments

Investors for the first time accepted negative returns for the privilege of owning rock-solid German government bonds on Tuesday as fears of a possible Brexit and economic worries caused a rush to the safety of German debt.

While borrowers traditionally pay interest on the money they are loaned, in the face of heightened political and economic uncertainty, those interest rates have come down to record lows recently as investors flock to safe havens to park their cash.

German government 10-year bonds are considered a benchmark of financial security and strong demand for the bonds, known as Bunds, caused prices to peak, in turn pushing their yields into negative territory for the first time ever.

In afternoon European trading Tuesday, the Bund yielded minus 0.028 percent, the immediate cost to anyone holding the investment.

Ditching any hope of a return on their investment now seems a reasonable price to pay to escape the uncertainties of falling stock markets or volatile commodities and currencies.

The 10-year German government bond is regarded as one of the safest investments and among the factors driving the current rally in Bund prices are concerns about the global economy, rock-bottom inflation expectations in the single currency area and fears about a possible Brexit with the British referendum on EU membership just 10 days away, traders said.

"A huge driving factor behind the current price trend is the heightened uncertainty over a possible Brexit, which is driving investors into the safe haven of German sovereign bonds," said DeKaBank economist Ulrich Kater.

European stock markets felt the pressure from rising Brexit panic again on Tuesday, with London's FTSE index dropping 1.3 percent, Frankfurt's DAX down 0.7 percent and the CAC-40 index in Paris falling 1.2 percent.

- Sterling slips -

Bond yields in the UK, although still positive, also dropped as money flowed into the market, reaching 1.13 percent for the 10-year British government bond compared to 1.14 percent on Monday.

The British pound dropped further as the bookmakers put the chances of Britain leaving the EU at around 42 percent.

Sterling fell over one percent on the day against the dollar, to $1.4108 per pound, and by 0.2 percent against the euro at 1.2608 euros per pound.

Nervousness translated into rapid price movements of sterling, known as volatility, that some analysts compared to jitters last seen during the 2008 financials crisis.

"Sterling volatility is currently 30 percent above its highest point during the 2008/2009 financial crisis," noted Kallum Pickering at Berenberg.

Interest rates on sovereign debt have been low for some time as central banks snap up government bonds from investors in an effort to boost economic growth through increased liquidity.

Be it in Japan, the United States, Switzerland or Britain, the rate of return for sovereign bonds of most major industrialised nations are striking new record lows in day-to-day trading.

Fitch ratings agency estimates that some $10 trillion (9 trillion euros) worth of sovereign debt was yielding a negative return at the end of May.

That has sparked fears that a rise in interest rates could see the stampede into bonds turn into a stampede out.

"The drop in yields below the zero mark once again shows the immense challenges currently facing global financial markets," Kater said.

"Weak growth is pulling down inflation expectations even further. Central banks are trying to counter falling inflation expectations using aggressive monetary policy," he said.

The European Central Bank has slashed its key interest rates to zero and launched a massive bond-buying programme known as quantitative easing (QE) in a bid to get the eurozone economy back on its feet and push inflation higher.

"Fears that Britain will quit the EU has killed off any willingness to take risks in European capital markets," said LBBW analyst Werner Bader.

- Good for taxpayers -

Germany's own finances have benefitted from its safe-haven status in recent years, because with investors favouring German sovereign debt, borrowing rates in Europe's biggest economy have come down.

The government has seen its annual interest payments fall from more than 40 billion euros ($45 billion) per year in 2008 to 21 billion euros in 2015.

The reduced debt servicing costs enabled Germany to balance its budget in 2014 for the first time since 1969 and a year ahead of target.

The finance ministry declined to comment on the drop in Bund yields on Tuesday.

At the German national financial agency, or Finanzagentur, which is responsible for managing the country's public debt, a spokesman said that the drop to negative yields should not be seen in terms of either good or bad.

"The government's debt management is done on a long-term perspective. The current level of yields is of secondary importance," he said.

"The main aim is to reach a sustainable balance between costs and reliability of planning," he continued.

But from the taxpayers' point of view, "negative yields are certainly pleasing because they reduce interest payments in the federal budget."


© 2016 AFP

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