The ongoing scramble for German safety away from French political uncertainty, has led to yet another blow out day for German 2 Year Schatz, with the yield tumbling to a fresh all time low of -0.92%, as Eurozone breakup concerns have spread from the bond market, and are now pressuring the euro sending the EURUSD below 1.05 for the first time in over a month.
The rush into German paper and out of France, means that the 10Y Greman-French spread has topped 0.8%, the widest in over four years, while the 2Y US-German spread is now well over 2%, the widest since at least 2000.
Granted, there was a brief moment of respite moments ago, when France 10Y Bonds briefly rallied after the latest OpinionWay poll found momentum for Le Pen stalling, sending French 10y bonds higher, and the yield lower as much as 5bps before paring loss to 2bps, although that burst of optimism appears to have quickly faded.
Adding to the German bid are signals that the ECB is buying German bonds, in particular those with a yield below the -0.4% deposit rate. With investors holding off selling their short-end German debt as they are used as collateral to receive cash at the ECB, fears have reignited of a collateral squeeze similar to late in 2016 which Draghi attempted, and failed, to address in the December ECB meeting.
Ironically, the rush into 2 Year paper took place even as Germany suffered another technically "failed" 30Y auction, in which the Bundesbank was forced to retain 41.8% of the auction as only €733 million bids were tendered for €1 billion in the offered 30Y paper at a yield of 1.04%.
The decline in the 2-Yr yield has been much more pronounced (falling 13bps from Friday) since Le Pen's significant narrowing in the Presidential poll seen at the back-end of last week (now over 40%). The political uncertainty regarding the French Presidential election has filtered into FX markets, weighing on EUR, which is now hovering at 6-week lows having made a break below 1.0520, however the downside has been curbed at 1.0500 led by the upside in EUR/GBP.
As Bloomberg confirms in a note this morning, "German two-year yields are turning ever more negative in the build-up to France’s elections as demand for the securities saturates supply. It’s a reason for caution, and it’s weighing on the euro. "
- Yield reached record-low of -0.915%; the notes are in a sweet spot should investors price in greater risk of a euro- area break-up and pile into securities closest to cash; French candidate Marine Le Pen has threatened to quit euro area
- German notes are also being supported because they’re the top assets for use as collateral in the euro area and ECB buying has made them more scarce.
- Bloomberg adds that central banks in Switzerland and the Czech Republic could also be mopping up German securities as part of their efforts to curb their currencies’ appreciation against the euro.
- France’s notes have been underperforming versus Germany; the two-year yield spread stands at close to 50bps, the widest since May 2012. The spread level is well above its five-year average, and statistical analysis shows it may have room to narrow back toward 36bps. But look to the April 2012 high of 83bps as a guide for how far the spread could go if risks escalate in as France’s election draws near
With US equities ignoring all adverse political news, keep an eye on the German bond market, where the 2Y has emerged as one of the last remaining barometers of political risk.