After rising earlier in the week, yields fell yesterday. But that rally proved short-lived, as the 10-year Bund yield ended the session above 2.8% again.
What remained of the day was again a feeling of risk aversion. Equities ended in the red and European sovereign spreads widened markedly even as yield levels briefly fell. The key spread of Italian 10-year bonds over the German Bund is now above 190 basis points, solidly returning to the range that prevailed before the summer. But the enlargement was not limited to Italy. We saw a widening of spreads in Greece and other peripheral countries, although not as pronounced.
Maybe it’s the medicine that’s needed. Real rates are rising again and the five-year real ESTR OIS is moving towards 0.6%, a level it had only briefly surpassed in July during this tightening cycle. Inflation swaps are coming off their highs, with the 5-year and 5-year inflation forwards down another 2 basis points after Monday.
Perhaps most surprising in the context of sour risk sentiment was the fact that Bund asset swap (ASW) spreads changed little; They are generally sensitive to risk aversion. And even more notable when the German debt agency yesterday cut issuance targets for the fourth quarter more than expected. Bond sales for the quarter were reduced by €8 billion and Bubill sales by €23 billion.
There was only a very short-lived rise in Bund ASWs due to weaker collateral supply prospects, but we have to acknowledge that current conditions in the high-quality collateral markets look quite benign judging by the relatively trading Bubills. cheap compared to swaps. And going from Bubill’s current outstanding stock of €155 billion to €148 billion by the end of the year, as now planned in the new financing schedule, does not represent a dramatic change from prevailing conditions, even if the original plan was to bring the stock to 171 billion euros.
In terms of more direct impact, we also have to wait until October, when the Bundesbank ends the remuneration of government deposits, which according to the latest reading were around €38 billion at the end of last week. This could still push the collateral market. However, it is worth noting that the debt agency itself has said that its balances have already been moved to the collateralized money market and are now close to zero.