While equities seem to have recovered most of the losses from last week’s renewed tariff fears, Bund yields paint a more pessimistic picture. The 10Y Bund yield is down to June levels, when there was significant macro uncertainty in the wake of Trump’s ‘Liberation Day’. Since then, the eurozone growth outlook and equities have improved materially, helping to push up euro rates. But somehow the past few days have seen a disproportionate drop in Bund yields, seemingly breaking the link with equities.
The swap spread is playing an important role in the decline of Bund yields, potentially reflecting a demand for quality. The 10Y Bund yield has been trading 1bp below swaps for a few days now. From a structural perspective, one would argue Bund yields should trade significantly above swaps, especially given the additional supply from German spending plans and quantitative tightening. But markets may be more focused on the near term, in which we could see more risk-off episodes like the past few days. This then would argue for an increased flow to safe haven assets like the Bund.
However, it may be simply due to the low supply of government bond issuance this month. In fact, we expect the issuance net of redemptions to be negative in October, which means markets have very little to absorb. This also helps explain the benign environment for spreads of European government bonds versus Bunds, which have seen a decent tightening recently, despite lower Bund yields. France’s attempt at another budget was well received by markets, bringing the spread down some 5bp over the past week. And that while the pension issue may simply be pushed back for a future government to resolve.
