What German Bond Yields Are Telling Us
Justifiably, much of the media focus on global markets this past week has been on Southern European treasury yields, which spiked further upward as investors priced in an increasing likelihood of a Greek default. To me though, the far more interesting and meaningful market move of the week, has not been on Southern European bonds, but rather their Northern European counterparts. When the German 2-year treasury bond yield was trading at 0.70% earlier in the week, my colleagues at Business Monitor cautioned that the yield could fall further by up to 20bps. A day later, the yield had plummeted to a new record low of 0.59%. Of course, much of this has to do with the spike in risk aversion and flight to safety within the Eurozone that came with the collapse in the Greek and Portuguese treasury markets. That said, I think there is more to this story than simply risk aversion.
(Click on chart for full size)
Germany - 2-year treasury yield, %
Falling German yields (across the curve) has been a trend in play for several months now, suggesting that the markets are pricing down interest rate expectations in the eurozone through the long term. This would fit the broader macroeconomic theme of deleveraging and deflation in Southern Europe and low growth across the eurozone. Moreover though, should German yields fall to that 0.50% level my BMI colleagues mooted, than I think we would have to seriously contemplate the implications for ECB monetary policy. Beyond just pushing back the scheduled interest rate normalisation to 2011, the Greek crisis could yet result in another ECB cut. After all, the Czech National Bank surprised with a 25bps cut on May 6. The risks of ECB quantitative easing are also rising. After all, if a EUR110bn Greek bail-out package agreed to on May 1-2 was insufficient to calm the treasury markets in Southern Europe, than surely the next logical step forward is for the ECB to begin buying up government debt.In turn, this would add to the disaster befalling the euro. A move down to US$1.1600/EUR is looking more and more likely.