Published by Global Banking and Finance Review
Posted on March 11, 2025
3 min readLast updated: January 2, 2026
By Stefano Rebaudo
(Reuters) - After a seismic shift in German bonds, a pocket of the market is trading at levels close to those normally associated with financial crises, suggesting the euro zone safe-haven benchmark might be nearing a tipping point.
The gap between 10-year swap spreads on the euro area's main risk-free benchmark and German Bund yields is pushing further into negative territory and last week touched -29 basis points -- levels last seen in 2010 when the euro debt crisis was brewing.
While such moves would ordinarily signal investor concern about anything from credit availability to market stability, this time they likely reflect expectations for a jump in German government bond sales to fund defense spending, analysts say.
German 10-year bonds last week suffered the worst weekly selloff since the 1990s as parties likely to form Germany's next government proposed a radical overhaul of spending rules.
German government bonds typically have traded at a premium to swaps because of Bund scarcity and the higher credit risk involved when a bank is the swap counterparty.
But that's now changed with new dynamics in play, including expectations for higher bond issuance and the European Central Bank stepping back from its bond buying role. This has also meant scarcity of German bonds in the market has eased and this corner of the bond markets has seen a dramatic shift.
Investors said they still saw Bunds as the safest euro zone asset and were adjusting to expectations for increasing supply. "Bunds might cheapen a bit more compared to swaps, but we think the bulk of the adjustment is behind us, and the markets have priced in the new regime to a large extent," said Konstantin Veit, portfolio manager at bond giant PIMCO. "Market expectations regarding German near-term fiscal expansion might have overshot a bit," he said, arguing that details about German fiscal plans would be crucial.
Uncertainty surrounding the impact of Germany's spending splurge was expected to remain elevated, weighing on Bund swaps.
Germany's Greens on Monday vowed to block the reform plans by likely next chancellor Friedrich Merz but forwarded rival proposals in a bid for a compromise.
Bund yields have come down from last week's highs, meaning the gap over swap spreads was trading at around -22 bps on Tuesday -- off but not far from last week's levels.
Still, analysts expected swap rates to trade at a premium to German bonds ahead.
"The Bund cheapening versus swaps will continue to be the direction of travel, with Bund yields which can reach 3%," said Rohan Khanna, head of euro rates strategy at Barclays.
Germany's 10-year Bund yield is around 2.85%.
"Recent moves do not signal debt sustainability concerns, Germany is just catching up with other U.S. and European markets," he added. "In all these jurisdictions, bonds trade much cheaper than OIS (overnight index swap) markets."
Analysts said they were also watching the direction of European Central Bank policy.
"If the ECB signals that it's willing to support markets by stopping QT (quantitative tightening), a further cheapening of Bunds versus swaps can be quite limited," said Michiel Tukker, senior European rates strategist at ING, referring to a process where the ECB scales back bond purchases.
(Reporting by Stefano Rebaudo; Editing by Bernadette Baum)
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