Weekly Market Outlook

Bond Investors Losing Faith in Central Banks Turn to German Debt

Investors are showing little appetite for repeating the rebellion against record-low government bond yields in Europe that peaked this time last year.

As faith in central bankers’ ability to boost economic growth and revive inflation diminished, German 10-year bund yields slid to a record this week. The previous low set in April 2015 was followed by a spike in yields that pushed them up by more than a percentage point in less than two months.

There’s so far no sign of a repeat of that happening this year, with demand for options that give the right to buy bund futures, or calls, versus those to sell, or puts, rising this week to the highest in almost two months, based on closing prices.

Standard Life Investments Ltd., the biggest money manager in Edinburgh, has a relatively long European position versus the U.S. within its bond portfolio, though it expects most of the gains to come from higher-yielding sovereign bonds. A long position is a bet an asset’s price will rise.

“Low yields are really telling you that markets think we are generally trapped in a low-return world,” said Jeremy Lawson, chief economist at Standard Life Investments, which manages about $364 billion. “The market has arrived at the view that central banks — as long as they keep policy accommodative — are able to prevent routs in markets, but they are not able to generate strong growth.”

Fed Outlook

European bonds rallied with counterparts across the world in the week after a U.S. report released June 3 showed the weakest payrolls in almost six years, damping wagers the Federal Reserve will raise interest rates in the next few months. Euro-area sovereign bonds returned 1.2 percent on average in the month through June 9, more than twice the 0.5 percent gain on Treasuries, Bloomberg World Bond Indexes show.

A report due June 16 will confirm that annual consumer prices in the euro area declined in May for a second consecutive month, according to a Bloomberg survey of economists. The European Central Bank, which is pumping 80 billion euros ($90 billion) a month through its asset-purchase program into the bond market, started buying corporate debt this week.

Record Lows

Benchmark German 10-year bund yields fell five basis points, or 0.05 percentage point, this week to 0.02 percent as of the 5 p.m. close in London on Friday, having dropped to 0.009 percent, the lowest since Bloomberg started collecting the data in 1989. The 0.5 percent security due in February gained 0.465, or 4.65 euros per 1,000-euro face amount, to 104.635.

Last year’s rally pushed the yield to as low as low as 0.049 percent in April, before they surged to as high as 1.06 percent on June 10, 2015.

Bill Gross, the manager of the $1.4 billion Janus Global Unconstrained Bond Fund, said in a tweet this week that central banks have created “a supernova that will explode one day.” In April 2015, Gross, a former chief investment officer at Pacific Investment Management Co., said bunds were the “short of a lifetime.

The slide in German yields widened spreads with Italian and Spanish peers as the U.K.’s upcoming referendum on its European Union membership fueled demand for havens.

The extra yield that investors get for holding Italian 10-year bonds instead of similar-maturity bunds jumped to 1.36 percentage points Friday. That’s the most on a closing price basis since February and up from less than a percentage point at the end of last year. Spain’s 10-year yield spread with Germany was at 1.41 percentage points, compared with 1.14 percentage points on Dec. 31.

“There is probably limited upside from here but also limited prospects of bunds selling off,” said Standard Life’s Lawson. “We expect most of the gain from being long European bonds to come from peripheral spread narrowing.”