German Bund yields recorded on Thursday the biggest two-day jump seen since the darkest days of the euro zone crisis in 2011, as poor market liquidity exacerbated the impact of data confirming the euro zone had ended four months of deflation. The data came after a surprise jump in German consumer prices on Wednesday and alongside the first rise in private lending in the euro zone for three years. That confirmed to some investors the European Central Bank's bond-buying scheme was having an effect.
But analysts said the resulting rise in yields, which was part of a global sell-off, caught many in the market off guard and was badly timed before upcoming holidays. Ten-year Bund yields rose 9 bps to 0.37 percent, near the 0.397 percent mark hit the day before the ECB launched its trillion euro bond buying programme on March 9.
Since markets opened on Wednesday morning, yields have risen over 20 basis points, a move the scale of which has not been seen since November 2011 when a euro zone debt crisis threatened to split the currency union. "It is a perfect storm," said Mizuho strategist Peter Chatwell. Many investors had expected the ECB's trillion-euro quantitative easing (QE) scheme to drive German 10-year yields towards zero or even into negative territory. Few were ready for such a reversal.
The initial selling, which traders said originated in futures markets, quickly snowballed. It was worsened by poor liquidity now that central banks have snapped up large portions of government debt with their QE programmes. The financial crisis caused by the collapse of Lehman Brothers in 2008 has also led to more prudential regulation, limiting banks' ability to hold large amounts of bonds for too long and reducing their market-making abilities.
"It's a sign that liquidity has been reduced quite a lot because of the ECB's government bond purchasing programme," said Elwin de Groot, a market economist at Rabobank. "If a couple of investors are selling in this market ... this creates a spiral. A lot of investors then try to leave through the same door." Traders said there were few buyers because of European holidays on Friday and month-end reporting. They also said the ECB and national central banks has not stepped up their QE purchases despite the rise in yields, which has expanded the pool of eligible bonds.
Spanish and Italian 10-year yields were unchanged at 1.47 percent and 1.46 percent respectively, after jumping 12-13 bps on Wednesday. Commerzbank analyst Markus Koch called Wednesday's moves in the bond market a "flash crash". "Markets will have to get used to these erratic swings going forward with banks being forced to curtail their balance sheet capacities and central bank interventions further undermining trading liquidity," Koch said.
Large debt sales in Germany, Italy and Portugal on Wednesday could also explain the scale of the move as investors struggled to digest the new bonds. Markus Allenspach, head of fixed income research at Julius Baer, said there were other technical factors in secured lending markets that have contributed to the rise in German yields over the last week. The soaring cost of borrowing German bonds in repo, which has pulled down yields in cash markets, has eased since the Bundesbank provided on April 23 a list of bonds it has purchased under QE and would lend to back to the market.
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