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Bond Yields at Records Suggest Limited Declines in 2015

One year ago many investors were forecasting a euro-area recovery and rising bond yields through 2014. Twelve months later they’re asking how much more the European Central Bank can boost the economy and how much further yields can drop.

When the 10-year German bund yield was at 1.84 percent, back on Dec. 16, 2013, analysts predicted the rate would climb to 2.20 percent at the end of this year. Instead it dropped to a record low as did yields from Italy to Ireland amid growing investor speculation that the ECB will overcome opposition from some of its own officials to begin large-scale purchases of government bonds in early 2015.

Monetary policy makers led by Mario Draghi have signaled they may expand stimulus to include quantitative easing after inflation slowed to the weakest in five years. While buying sovereign debt may push euro-area yields even lower, any resultant uptick in inflation and growth may also reduce demand for the region’s safest assets in the longer term.

“Since they’ve already committed so much to it and raised expectations, not delivering could be particularly damaging,” Gianluca Ziglio, executive director of fixed-income research at Sunrise Brokers LLP in London, said in a Dec. 19 telephone interview. “Why should you invest in bunds with yields at 60 basis points if you expect QE to happen and be successful?”

Plunging Yields

Yields across the region plunged to all-time lows this year as the ECB cut its deposit rate below zero for the first time, unveiled an unprecedented program of asset purchases and said an expansion to include government bonds is possible. The average rate on euro-region sovereign debt dropped to 0.8771 percent on Dec. 23, the lowest on record, according to Bank of America Merrill Lynch indexes.

Spain’s 10-year yield dropped to a record 1.644 percent on Dec. 23 from 4.15 percent at year-end. The same day, Italy’s reached 1.911 percent, less than half its 4.13 percent level closing 2013. Portugal’s tumbled to 2.679 percent a day earlier, and Ireland’s scraped 1.262 percent in the previous week.

The plunge in yields has tracked a decline in expectations for the euro-area economy. The region expanded 0.8 percent this year, according to the economists surveyed by Bloomberg, missing the 1 percent growth forecast by analysts in December 2013.

Sell Holdings

“Investors pre-empt what the central bank will do, so they already started to take positions but then as it gets announced they decide to sell their holdings,” Charles St-Arnaud, a London-based economist at Nomura, said in a Dec. 23 interview on Bloomberg Television’s “On The Move” with Guy Johnson. “But then as the ECB start to do the purchases you could see yields again going slightly lower.”

The region’s higher-debt and -deficit nations have been taking advantage of the low-rate environment to refinance. Portugal last month exchanged bonds to extend their maturities, easing the repayments it faces in the next two years after it exited its three-year bailout program in May.

As of Nov. 13 the nation had already raised funding for more than half of its 2015 financing needs, according to Finance Minister Maria Luis Albuquerque. It was the best-performing euro-area debt market this year through Dec. 23, returning 22 percent compared with 13 percent across the region, according to Bloomberg World Bond Indexes.

Yield Forecasts

While the median estimate of analysts surveyed by Bloomberg forecasts 10-year bund yields will climb to 1.1 percent by the end of next year, the implied forward predicts a far more limited advance to 0.73 percent. Implied forwards compare rates over various terms in a technique known as gap analysis.

Benchmark German 10-year yields fell to a record 0.541 percent today after Greece’s Prime Minister Antonis Samaras failed in his final attempt to get his candidate for president confirmed, triggering snap parliamentary elections and boosting demand for the euro area’s safest fixed-income securities.

More than 90 percent of respondents in Bloomberg’s monthly survey, conducted through Dec. 11, predict the ECB will start extended purchases next year, up from 57 percent in November. An announcement will probably come in the first quarter, with any decision taken against the objections of some policy makers, the poll of 55 economists showed. ECB policy makers are set to meet next on policy on Jan. 22.

“You would have to suggest the vast majority of QE effect is priced in” to bund yields, Charles Diebel, head of macro strategy at Aviva Investors which manages about 241 billion pounds ($ 374 billion), said in a Dec. 19 telephone interview. “I find it difficult to build a bullish case for bunds.”

To contact the reporter on this story: Lucy Meakin in London at [email protected]

To contact the editors responsible for this story: Paul Dobson at [email protected] Keith Jenkins

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