German yields steady, spreads tighten after recent repricing

By Stefano Rebaudo

(Reuters) – German borrowing costs were little changed and spreads between the core and periphery tightened on Wednesday, as investors anticipated little upside for yields in the short term after last week’s European Central Bank meeting spurred repricing.

While investors are concerned about more public spending in 2023 to fight the energy crisis, the ECB pledged further interest rate hikes and said it would reduce its bond holdings in March.

German short-dated yields edged up to their highest in more than a decade, with the two-year yield up 1 basis point (bp) to 2.52%. It was around 2.2% before the ECB met.

“I think we are done, at least for now, after the yield rise which followed the ECB policy meeting last week,” said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

Germany’s 10-year Bund yield, the euro zone’s benchmark, was down 1 bp at 2.29%.

ECB euro short-term rate (ESTR) forwards price in the depo rate to peak at around 3.4% in the summer of 2023, from about 2.8% before last week’s meeting.

“Bond prices should hover around the current levels from today to year-end,” Maxia added.

Italy’s 10-year government bond yield fell 5 bps to 4.42%, with the closely watched spread between Italian and German 10-year yields tightening to 212 bps. It widened from 190 to 220 bps after the ECB.

The Bank of Japan (BOJ) shocked markets on Tuesday with a surprise tweak to its bond yield control that allows long-term interest rates to rise more, but analysts expect limited spillover effects.

“Japanese buyers are already overweight U.S. dollar cash” and other currencies, said George Saravelos, strategist at Deutsche Bank, referring to the impact of the BOJ policy shift.

“They will use it to buy yen and Japanese bonds as domestic yields rise. By extension, the domestic and foreign bond market adjustment is likely to be fairly orderly,” he said, adding that the biggest market impact is likely on forex.

Since last week’s ECB policy meeting, German real yields have been in positive territory. The 10-year inflation-linked rate was at 0.13%. It hit its highest level since February 2014 at 0.273% on Oct. 21.

The targeted longer-term refinancing operations (TLTRO) repayments will settle today. Euro zone banks are set to repay early another 447.5 billion euros ($474.62 billion) in multi-year ECB loans.

“In theory, this should support the transmission (of the money market) into the new 2% ECB depo rate,” said Christoph Rieger, head of rates and credit research at Commerzbank, adding that the new rate on repo specials was bid at around 1.75%.

($1 = 0.9429 euros)

(Reporting by Stefano Rebaudo; editing by Barbara Lewis, Paul Simao and Josie Kao)