(Recasts with further fall in Bund yields, fresh analyst
By Emelia Sithole-Matarise
LONDON Aug 15 German Bund yields hit a new
record low on Friday as reports of attacks in Ukraine on a
Russian convoy added impetus to a market buoyed by bets for more
European Central Bank policy easing.
A Ukraine military spokesman said Ukrainian forces had
engaged and destroyed part of an armed convoy that Russia says
is humanitarian aid for pro-Moscow separatists in eastern
The confirmation by Kiev that its forces clashed with
Russian troops inside Ukraine spurred flows into assets
perceived to be safe such as top-rated German, U.S. and British
bonds. Riskier assets such as equities cut gains.
Bund yields dropped 5.6 basis points to a record low of
0.958 percent, notching their biggest weekly
percentage fall since the week ending Sept. 27, 2013.
They initially breached that 1 percent level for the first
time on Thursday after data showed the euro zone economy failed
to grow in the second quarter, even before sanctions the West
and Russia imposed on each other over the conflict in Ukraine
started to bite.
Many in the market expect yields to hug these lows or go
even lower in coming days if the fighting in Ukraine escalates
over the weekend and as the outlook on the euro zone economy
increases expectations of more aggressive policy easing from the
European Central Bank.
"There's the huge risk that there could be a major military
involvement of Russia in Ukraine and this would be an even worse
situation compared to the one we had when there was this
(Russian) involvement in Crimea," said Daniel Lenz, a bond
strategist at DZ Bank.
"The Bund is very much the heat curve (map) for what's
happening in this geopolitical situation. Now I would not bet on
any limit to the downside (in Bund yields) if there really was
an attack on this Russian convoy."
Yields on lower-rated Italian and Spanish bonds also hit
all-time lows at 2.579 percent and 2.272 percent
respectively, on the market belief that the ECB will eventually
have to embark on asset purchases, a monetary policy tool known
as quantitative easing.
The ECB is unlikely to take fresh measures in the next few
months as it wants to assess the impact of cheap four-year loans
to the banking sector it will start to dole out in September and
But pressure on it to act sooner rather than later could
accelerate next week if preliminary euro zone manufacturing
activity data shows counter sanctions between the West and
Russia are beginning to take a toll.
"If QE expectations do accelerate, expect sharper moves
downward in Bund yields, but if QE continues to be delayed, this
will also benefit nominal bonds as the market will price
mounting deflation risk and a central bank far behind the curve.
Neither hurts core bonds," RBS strategists said in a note.
They said they would not be sellers of Bunds even if yields
were to fall below the 0.96 percent level. That is the level at
which Bunds would become "statistically expensive", according to
the RBS strategists' own fair-value models which take into
account inflation, private sector loan growth and manufacturing
"Even if Bunds get to 95 basis points, we would not be
sellers with data momentum still slowing; rather, our concern
would be that longs (buyers) would move further down the curve
from 10-year (Bunds)," they said.
The ultra-low level in German yields is stoking fears that
the euro zone is facing a "lost decade" of economic stagnation
and incessant struggle to lift inflation, similar to that of
Some in the market are, however, cautious.
"We still don't believe the euro area is going into
Japan-style deflation," said Martin Harvey, portfolio manager
(fixed income) at Threadneedle Investments.
"Therefore on the medium-term basis we think the (Bund)
valuations here are poor but you have to respect that the
changes that we've seen over the last couple of weeks are going
to influence those yields lower still. We maintain a defensive
position in terms of bond markets," he said.
(Editing by Susan Fenton)