German key yield back above 0%. Here's what it means

LONDON, Jan 19 (Reuters) - Bond markets have just passed a major milestone -- German 10-year yields have shot above 0% for the first time in nearly three years, potentially marking a return to more normal borrowing conditions in Europe.

Negative bond yields in Germany, the euro zone's benchmark issuer, are a result of aggressive bond-buying by the European Central Bank, deployed to lift inflation which had undershot its target for years. So Wednesday's rise in Bund yields to as high as 0.025% is significant.

"It's driving home the message that yields are on their way up and that the era of 'lower for longer' is over," said ING senior rates strategist Antoine Bouvet.

Germany's Bund yield turns positive for the first time since 2019


Euro zone inflation is at a record-high 5%, well above the ECB's 2% target, and the economy is recovering from the COVID-19 pandemic, so ultra-low yields no longer look justified.

Wednesday's data showing British inflation at its highest in almost 30 years reinforced that price growth everywhere is proving sticky.

Bund yields have soared 40 bps in the past month alone, a very different environment to 2016, when the ECB expanded bond buying to fight deflation and forced 10-year yields below 0% for the first time.

Euro zone inflation at a record high


One driver pushing German borrowing costs higher is U.S. Treasury yields, which have surged on expectations the Federal Reserve could start interest rate hikes in March and even look to wind down its $8 trillion-plus balance sheet.

The ECB's 1.85 trillion euro pandemic emergency bond-buying scheme expires in March and money markets are pricing in two euro zone rate hikes before year-end even though the ECB insists price growth will abate on its own by the end of this year.

The ECB will remain present in bond markets but for the first time since 2019, the net supply of bonds issued by euro zone governments are slated to outstrip ECB buying this year. read more

Supply outlook from BofA


Low yields in Germany and other high-grade issuers have long pushed investors into riskier assets such as equities, junk-rated bonds and debt from weaker sovereigns like Italy.

Bunds at a mere 0% won't immediately change that picture but further rises could diminish the allure of such assets. Policy tightening is already raising the risk premia from heavily indebted Southern European countries as well as from companies.

Many argue however that with inflation-adjusted yields still deeply negative, investors will keep chasing riskier assets. That explains why equities are near record highs even as sovereign yields rise. read more

"In a gradual, orderly sell-off on the back of improving macro fundamentals and a positive risk backdrop, I don't think it's that major a problem," UBS strategist Rohan Khanna said.

Italian and junk bond yields spreads


Germany has almost $2 trillion of outstanding debt, with 10-year bonds accounting for some 40% of issuance. So yields above 0% will sharply shrink the negative-yielding bond pool.

Globally, as much as $18 trillion worth of debt traded with negative yields in late 2020, according to the Bloomberg Global Aggregate Negative Yielding Debt Index. Now, that pool has shrunk to roughly $9 trillion.

Reuters Graphics

Sub-zero yields mean investors pay the issuer to hold their debt. That's been good news for governments but not for banks and investors such as pension funds, which need higher yields to match long-term liabilities.

"It will be definitely celebrated as a step towards a more normal environment," said Antonio Cavarero, head of investments at Generali Insurance Asset Management.


It's not a paradigm shift -- most investment banks still expect Bund yields to be around or barely above 0% by end-2022.

ECB projections still suggest inflation will end up at 3.2% on average this year and fall back below the bank's 2% target in 2023. It suggests the euro zone central bank, unlike its U.S. or British peers, won't be hiking rates imminently.

Reporting by Dhara Ranasinghe and Yoruk Bahceli; Editing by Sujata Rao and Catherine Evans

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