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What’s the German for ‘déjà vu’? One year on from the springtime madness that supercharged the German government bond market, Bunds are on fire again. Current betting is that the country’s 10-year benchmark bonds are on the train to La La Land. Sky high bond prices, and negative yields, here we come.

Investors are supposed to buy super safe bonds to avoid the risk of making losses on riskier bets. Now, they’re lining up to make a guaranteed loss on that super safe paper.

In the last rally, it was the start of a deflation-fighting bond buying programme by the European Central Bank that acted as a magnet to speculators. From more than 0.5 per cent at the start of 2015, yields tanked to 0.048 per cent at one fleeting point last April.

The rally seemed unstoppable. But it stopped, suddenly — particularly when fears that the world would run out of bonds ebbed. The snap back, with yields racing back up to almost 1 per cent by June, was humbling.

It has taken investors time to warm to super skinny Bund yields again. However, with Japan now selling fresh 10-year bonds at negative yields, few would even be surprised to see German yields, now around 0.13 per cent, turn negative. Already, half of the European government bond market yields too little for the ECB to buy it. Anything yielding less than the deposit rate of -0.3 per cent is off limits.

Of course, what the ECB does next is a big driver. A return to deflation means that the deposit rate is likely to fall further. Think not of how little the debt yields; think instead of how much further it has to rally if the ECB buys it off you at a yield of -0.5 per cent.

But along with other metrics, the market is saying that it doesn’t expect eurozone inflation to reach even 1 per cent for more than five years. That smells too pessimistic, particularly if oil stabilises.

Bunds are reflecting nerves on everything from a Chinese meltdown to a US interest rate mistake to a possible UK exit from the EU. Yields probably can and will sink below zero, and even stay there a while. And the doom-mongers may be right. But it would take only a glimmer of cheerfulness for this to unwind pretty brutally. Again.


Letter in response to this article:

Time to use low rates to lay foundations for growth / From Cyrique Bourbon

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