(Updates with German auction result)
LONDON, Feb 10 (Reuters) - Germany’s two-year bond sale drew strong demand on Wednesday, with safe haven flows and bets that the European Central Bank may cut its deposit rate by more than 10 basis points in March sugar-coating the minus 0.50 percent yield on offer.
Bond markets in southern Europe looked more stable after a sharp sell-off this week. Portuguese 10-year yields were down 12 bps at 3.43 percent after rising more than 30 bps on Tuesday as investors concerned about global growth and the health of the world’s banks moved money out of lower-rated markets.
Berlin sold almost 4 billion euros of a new bond, with yields only slightly above those in secondary markets. Negative yields mean that investors are willing to pay Germany to hold their money for two years.
Their motivation could be related to regulatory constraints, concern about the safety of higher-yielding assets or simply a bet that yields could fall further in a loose monetary policy environment globally.
“The minus 0.50 percent level at the auction is really eye catching. People are willing to pay so much to invest in Germany,” said Commerzbank rate strategist David Schnautz.
“What’s driving demand is that the ECB will do something for sure in March, at least the 10 bps that everyone is expecting.”
Bids surpassed 8.6 billion, ending a run of auctions this year where demand was tepid or even lower than the amount on offer. That was the highest level of bids for any German auction since March 11, 2015, which was in the first week that the ECB bought bonds as part of its bond-buying stimulus programme.
Almost one year later, analysts believe more measures are on the way as the ECB is fighting the impact of a slowdown in the Chinese economy, record low long-term inflation expectations due to subdued oil prices, and rising stress indicators in bank-to-bank lending markets.
Forward contracts of overnight EONIA interest rates dated for the March meeting are 13 basis points lower than the spot rate, meaning money markets see a one-in-three chance of a 20 basis point cut. A cut of 10 basis points is widely assumed.
Money markets factor in some 25 basis points worth of deposit rate cuts for 2016. German two-year yields were 1 basis point higher at minus 0.51 percent, in secondary markets. They were just off a record low of minus 0.536 percent.
Ten-year Bund yields, the euro zone benchmark, were a tad higher at 0.25 percent. Almost a year ago, Bunds tested the zero level, but their failure quickly escalated into a snowballing sell-off that took yields above 1 percent.
The context then was different, as markets were not risk averse and simply thought the ECB’s 60 billion euro a month bond buying programme, recently extended by six months, would wipe out sovereign borrowing costs across the euro zone.
But the memory of the painful April-May Bund sell-off makes many analysts remain reluctant to forecast zero yields.
“We recognise that, if the European Central Bank extends its QE programme, yields on German Bunds could fall further,” said Ken Leech, CIO of Western Asset Management, the largest subsidiary of Legg Mason with $440 billion of assets under management.
“However, given that their valuation is so extraordinary, with yields approaching zero, the risk-reward trade-off is just not compelling.” (Additional reporting by Simon Jessop; Editing by Gareth Jones)
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