German yields fall on French election worries

Investors bought short-dated German debt and forced yields down to a record low on Wednesday as concerns over the future of the euro rippled through European markets.

Germany’s two-year Shatz yield, which moves inversely to prices, fell to minus 0.92 per cent, its lowest level on record, in a sign of unease about the outcome of France’s presidential election in April.

Investors are buying German paper in an effort to hedge against the prospect of victory for Marine Le Pen, the anti-establishment candidate, who has vowed to remove France from the euro.

“It all seems to be linked with the French political woes,” said Patrick O’Donnell, an investor at Aberdeen Asset Management, who described the sense of an “internal FX trade” in Europe and the safe heaven status of German assets.

“The [German] front end is the safest place to be,” he added. “If redenomination risk were to reappear, then the short-dated maturities of France and Spain would be the ones that would come under pressure.”

Investors’ positioning comes despite signs of strong economic growth in the eurozone, which has posted 14 consecutive quarters of growth. Economic sentiment is now at its highest level in six years.

“The main weight on the euro is presently not economic but political,’’ said Marc Chandler, strategist at Brown Brothers Harriman. “These concerns trump the eurozone economic data, which shows steady to stronger growth at the start of the year.”

Bond purchases from the European Central Bank have pushed German yields lower over recent weeks. This momentum has intensified after polls showed growing support for the Ms Le Pen’s National Front party, widening the gap between French debt and the bonds of Germany and other core eurozone members.

Dutch two-year yields also hit record lows on Wednesday, while French two-year yields, at minus 43 basis points, remain elevated compared with their lows of minus 0.67 per cent at the start of the year.

Peter Schaffrik, an analyst at RBC Capital Markets, said Germany’s short-dated bonds were now one of the “most sought after assets in financial markets”.

While the possibility of currency redenomination is still seen as extremely unlikely, the political volatility of the last year has left European investors on edge.

“People are sitting up and watching more so now,” said Mr O’Donnell. “They’ve gotten Brexit wrong, they got Trump wrong,” he added. “They don’t want to be getting another big political risk wrong.”

The gap between German and US two-year yields has widened to 2.1 percentage points — its highest since 1999, when the single currency was first introduced. The divergence between US and German yields is weighing on the euro, which touched a six-week low on Wednesday, trading below $1.05 to the dollar.

Yields on swaths of government bonds have been negative in Europe over the past year, with more than €1.5tn of asset purchases from the ECB pushing up the prices of bonds and forcing interest rates lower.

The ECB in December expanded the universe of debt it can buy to include bonds yielding below the deposit floor of minus 0.4 per cent. This has forced demand for two-year debt higher, and pushed yields lower.