Eurozone: Temporary support for Bunds to fade – BNPP

Patrick Jacq, Research Analyst at BNP Paribas, explains that 0.50% area has so far proved a solid cap on the 10y Bund yield and the limited rally since mid-March seems to have been driven by the fall in equity and oil prices, while the fall in nominal yields is the result of a fall in inflation expectations rather than lower real yields.

Key Quotes

“The decline of inflation breakevens was also probably due to the effect of carry on inflation. As the carry on inflation is set to return to positive territory soon, the fall in breakevens is expected to come to an end.”

“Into the quarter-end, scarcity-led richening in Germany could prolong the rally over the next few days. As the PSPP is draining paper from the market, scarcity is becoming more of an issue. This is particularly true going into end-of-quarter periods. Balance-sheet constraints add to illiquid conditions in some paper. German sovereign debt is particularly affected by scarcity, which saw the problem worsen at the end of last year. As the end of Q1 approaches, we expect limited dislocation in repo. German paper is likely to richen in ASW terms. It is worth noting that the quarter-end impact on ASW spreads and repo/eonia spreads is likely to be greater this time than it was a year ago.”

“Once Q1 is behind us, we expect a bearish bias on Bunds to return. After the recent rally, driven by lower inflation breakevens, nominal bonds could find further temporary support in the coming days. But positive carry on inflation should lead breakevens higher. We also expect Bunds to cheapen in ASW terms in early April. Finally, German paper benefited from relatively better net supply conditions than other eurozone sovereigns in March. This will change in April. We therefore expect the 10y Bund yield to push higher from its current level of about 0.40%.”