What more QE means for Bund yields
The 10-year Bund yield moved up from its recent lows of -0.71% to -0.45% on September 16, driven mostly by an element of disappointment regarding the European Central Bank’s (ECB) latest stimulus measures and some renewed hopes for a US-China trade truce. In particular, we suspect the rebound in yields was triggered by the ECB’s failure to increase issuer limits for its purchases of government bonds. This was a big disappointment for the sovereign bond market, as were news reports that some important ECB members were not in favour of restarting quantitative easing (QE).
By year’s end, we see the 10-year Bund yield falling back towards -0.6% as the German slowdown continues while, in our central scenario (to which we assign a 55% probability) global uncertainties surrounding trade tensions and Brexit, among others, will not have fully abated.
In a more positive scenario (15% probability), we could see the 10-year Bund yield moving up towards -0.2% by year’s end. This could happen if the German government decides to launch a large fiscal package, even should Germany experience only a mild ‘technical’ recession. In turn, this could push up the 10-year German inflation breakeven yield, which now lies below 1%. Another trigger for higher yields could be a comprehensive trade deal between the US and China.
Indeed, the US is still threatening to impose tariffs on European Union (EU) autos and auto parts. It goes without saying that such tariffs would be a deadly blow to the German industrial sector, which is already in recession.
By contrast, in a more negative scenario (30% probability), the 10-year Bund yield could fall further from current levels, towards -1.0%. This scenario could materialize in the case of a severe German recession, probably triggered by an external shock, whether US tariffs on European autos or a ‘no-deal’ Brexit. The upward pressure on yields emanating from the massive fiscal stimulus in reaction to such a shock would be more than offset by more ECB easing and the Bund’s safe-haven status.