Weekly Market Outlook

ECB Seen Supporting German Bonds After Biggest Selloff This Year

After inflicting the biggest weekly decline in German 10-year government securities this year, bond bears may have reason to pause when the European Central Bank provides its first analysis of the economic outlook since the U.K.’s shock Brexit vote.

Investors’ urge to extend a selloff that pushed benchmark 10-year bund yields to the highest since June 24 may be muted by the central bank emphasizing that it hasn’t run out of ammunition in its fight to avert deflation. Data released Friday showed annual consumer prices barely grew last month, more than a year since the start of an asset-purchase program that’s pushed yields on almost half the euro area’s $6.4 trillion of sovereign bonds below zero. The Bank of England signaled on July 14 it may inject fresh stimulus next month. The ECB’s next policy decision is set for July 21.

Italian and Spanish 10-year securities declined less than similar-maturity German bonds as investors speculated on how policy makers will deal with the growing scarcity of core bonds for the central bank’s quantitative-easing program. Having lagged behind in the rally that was sparked by Britain’s decision to leave the European Union, the securities yield about 1.2 percentage points more than bunds, making them attractive as an alternative to sub-zero yields. Germany auctioned new 10-year debt this week, its first with a negative yield, which also led to the benchmark yield climbing.

Germany’s benchmark 10-year bund yield rose 20 basis points, or 0.2 percentage point, this week to 0.006 percent as of the 5 p.m. London close on Friday, the biggest increase since Dec. 4. The price of the zero percent security due August 2026 was 99.94 percent of face value.

Yields on Europe’s benchmark sovereign debt climbed above zero Friday for the first time since June 24, having dropped to a record-low minus 0.205 percent on July 6. Toronto Dominion’s Kelly forecasts the 10-year bund yield will fall to minus 0.3 percent by year-end.

Germany’s government securities returned 0.8 percent in the past month through July 14, while Spain’s made 2.7 percent and Italy’s earned 2 percent, according to Bloomberg World Bond Indexes.

Spain’s 10-year bond yield rose eight basis points this week to 1.23 percent, while Italy’s increased six basis points to 1.26 percent.

‘Forward Guidance’

ECB President Mario Draghi “will continue to provide forward guidance that the ECB will act as needed,” said Richard Kelly, head of global strategy at Toronto Dominion Bank in London. “We have not seen the lows in U.K. and European yields. Outside of economic fundamentals, there is still a global reach for yield that will continue to hold long-end rates lower for longer.”