German two-year bond yield at record low on scarcity fears

November 23, 2016 4:47 AM EST

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By Abhinav Ramnarayan

LONDON (Reuters) - Germany's two-year government bond yield hit a record low on Wednesday on expectations that the European Central Bank will extend its asset purchase program beyond March 2017, exacerbating the scarcity of tradable bonds.

The two-year German government bond , or "Schatz", dropped to minus 0.75 percent, having dipped below minus 0.70 percent for the first time in months on Tuesday.

ING attributed the move to increasing collateral scarcity as short-dated German government bonds are often posted as collateral for short-term borrowing in repo markets.

"Not everyone has access to the ECB's deposit facility, so they turn to a safe place to put their cash," ING strategist Benjamin Schroeder said.

The ECB's bond-buying program, which has so far pumped well over 1 trillion euros into the system, has left many investors with an excess of cash.

The trend has seen high-grade two-year government bonds trade at close to record lows. Dutch and French equivalent bonds were yielding minus 0.71 percent and minus 0.62 percent respectively.

The French two-year yield is notable as the spread over German two-year bonds is just 12 basis points, whereas the equivalent 10-year spread is around 50 bps.

"The excess liquidity is flattening spreads at the short end," said Schroeder. "Also, the inflation trade and comments by Draghi have been contributing factors overall across the curve."

Euro zone yields have fallen this week after ECB policymakers, including President Mario Draghi, helped curb a sell-off in the bloc's debt by reaffirming their commitment to easy monetary policy, cementing expectations that the bond-buying scheme will be extended on Dec. 8.

Indicators pointing to solid economic growth in the bloc's two largest economies did not stop yields falling.

Survey results released on Wednesday showed Germany's private sector grew steadily in November, helped by stronger-than-expected activity at services companies, and France's business activity picked up in November, driven by faster growth in the services sector.

Despite this, the yield on the German 10-year bond, the region's benchmark, fell further to a two-week low of 0.21 percent, down 2 bps on the day.

Germany is due to sell 3 billion euros of the bonds. It will be the last German sale of 10-year bonds in 2016, and should attract interest as a result, ING said.

Lower down the credit spectrum, Portugal will sell five-year bonds to raise between 500 and 750 million euros.

Later on Wednesday, the U.S. Federal Reserve will release minutes from its policy meeting earlier this month.

Market expectations are for a December rate hike - CME's Fedwatch tool has the probability at 93.5 percent - but the minutes may give some clues on the pace of hikes in 2017 and beyond, Citi strategists said.

(Editing by Alexander Smith)



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