LONDON (Reuters) - With German bond yields sinking to new lows on an almost daily basis, some investors are looking to Switzerland as a yardstick for how low government borrowing costs in Europe’s biggest economy could go.
Germany’s benchmark 10-year government bond yield on Wednesday fell to -0.60% as an unexpected large rate cut from New Zealand and weak German data fuelled expectations for aggressive easing from major central banks.
Switzerland’s key interest rate is at -0.75% and its 10-year bond yield is at -0.96%, providing a guide for where euro zone yields could fall to if it is assumed that the European Central Bank cuts rates to as low as Swiss levels.
“Swiss 10-year bond yields are close to -1%, and with the ECB looking at the SNB (Swiss National Bank) for inspiration it’s entirely possible to imagine Bund yields down there in the future,” said Ross Hutchison, fund manager, fixed income, Aberdeen Standard Investments.
For sure, yields in Germany - the euro zone’s benchmark bond issuer - have dropped well below bank forecasts. Goldman cut its 10-year Bund yield forecast in June to -0.5% by the end of the year.
HSBC on Tuesday slashed its forecasts for U.S. and German yields in the face of expectations for weak inflation and central bank easing. It now expects German 10-year yields to fall to -0.8% from a previous forecast of -0.2%.
A scarcity of bonds from triple-A rated Germany, where supply has been low in recent years because of a budget surplus, alongside buying by the ECB for quantitative easing means there are long-term structural factors pushing yields lower.
Weak economic data, prospects for fresh rate cuts, and more stimulus are accentuating the trend, while risks such as Brexit mean demand for safe-haven bonds such as German ones are strong even though that means investors are paying the government to hold its debt.
“My point is that even if you don’t expect a recession in Europe, it will be a very difficult period because of the headwinds in the German economy,” said Mauro Vittorangeli, CIO conviction fixed income at Allianz Global Investors.
“So if you’re thinking about how far the rally can go on, take a look at the Swiss experience - yields can stay below the central bank rate for a long time in the presence of scarcity.”
The SNB has held rates at -0.75% since 2015.
In the euro zone, money markets fully price in a 10 bps cut in the ECB’s -0.40% deposit rate in September, followed by another by year-end and a further one by late 2020.
Jim Leaviss, a fixed income fund manager at M&G, said that the stimulative impact of further rate cuts on the economy was in question.
“Having said that, the deposit rate could be cut again - to as low as -0.75%? Who knows, but in that scenario the 10-year Bund yield at -1% wouldn’t be unreasonable,” he said.
Reporting by Dhara Ranasinghe; Editing by Hugh Lawson