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April 20, 2015

Strange Things in the European Bond Market

By Christine Hughes, Canada. Chief Investment Strategist, OtterWood Capital 

Strange things are happening in the European fixed income markets these days as our friends at RenMac pointed out this week. I watch these indicators too, and my jaw is on the floor as I watch their QE program unfold.

For starters they are buying 260% of all net bond issuance with their program. That means they are buying up more than 2.5 times what they are going to issue (less what will mature). What will be left looks like the red line on this chart:

Having supply sucked out of the system like that has an obviously large impact on prices. The more buyers there are of anything, the higher the price goes (and in the case of bonds, the lower the yields go).

As of this week German government bond yields are negative all the way out to 9 years in maturity. So that means to park your money in Germany for the next 9 years, you have to pay THEM. That is so backwards I can’t even begin to think of all the unintended consequences this will bring about.

The bigger question for me is if this heavily distorted government bond market is the reason for European swap spreads blowing out. Swap spreads are an indication of credit health of a given market. Higher swap spreads indicate financial stress, lower indicate easier, more benign conditions. Shown below are European 10yr swaps spreads on the rise since their QE began.


Are they rising because of the negative yields created by the ECB or are they actually indicating a growing risk of default in the Eurozone? With what’s going on with Greece (see here from my prior comment), it could very well be indicating that stress! In any event, it is well worth keeping a close eye on these indicators of financial stress.

Courtesy Christine Hughes, Chief Investment Strategist, OtterWood Capital via Wolf Street

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