German Bunds Rise, Italy, Spain Government Bonds Slide, on Recession Signs

Bloomberg

By Emma Charlton and Keith Jenkins - Sep 3, 2011 9:30 AM GMT+0300

German bunds surged this week, pushing 10-year yields to a record low below 2 percent, as signs the U.S. economy may be headed toward recession boosted demand for the safest securities.

Italian bonds dropped for a 10th day, and Spain’s benchmark rates climbed to the highest level in three weeks on concern debt purchases by the European Central Bank won’t be enough to cap the two nations’ borrowing costs. A U.S. payrolls report yesterday showed no jobs were added in August, stoking speculation the Federal Reserve will consider additional stimulus measures to boost the economy. Greek two-year yields soared above 47 percent.

“The reaction to the payrolls data shows that the market is pricing in a fairly gloomy scenario,” said Christoph Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt. “There was a sharp reaction in bunds, risky assets are plunging. It’s a confluence of factors with the euro-region debt crisis also clearly responsible for the underlying bid in the bund market.”

German 10-year bund yields fell 15 basis points this week to 2.01 percent, reaching a record low 1.996 percent yesterday. The 2.25 percent security, maturing in 2021 rose 1.345, or 13.45 euros per 1,000-euro ($1,421) face amount, to 102.170. Two-year note yields fell 13 basis points to 0.52 percent, the least since June 2010.

Ten-year bunds have risen in five of the past six weeks as disappointing economic data and concern the sovereign debt crisis is intensifying fueled demand for the perceived safety of government debt.

Manufacturing Shrinks

Europe’s manufacturing industry shrank more than initially estimated in August, data released on Sept. 1 showed, adding to signs the euro region’s recovery is faltering. Economists forecast a report next week will show German factory orders declined in July.

Italian 10-year yields climbed 21 basis points over the week to 5.28 percent. Yields reached 5.29 percent yesterday, the most since Aug. 8, the day the European Central Bank began buying the bonds. Two-year yields added 16 basis points to 3.52 percent.

The difference in yield, or spread, between 10-year Italian and German bonds reached 328 basis points, the widest since Aug. 8. Costs to insure Italian debt using credit-default swaps climbed to a record.

The ECB began buying Spanish and Italian government debt last month to curtail a surge in bond yields as contagion from the debt crisis that engulfed Greece, Ireland and Portugal infected the euro-region’s third and fourth largest countries.

Austerity Plan

Berlusconi on Aug. 29 bowed to demands from his party’s alliance partner to overhaul the 45 billion-euro austerity plan of Aug. 5, that had originally helped persuade the ECB to support Italy’s bonds. The changes create a 7 billion-euro hole in a package that aims to balance the budget in 2013, analysts at Societe Generale SA estimate.

“The Italian austerity plan is being chopped and changed and that’s undermined the ECB’s support of Italian bonds,” said Orlando Green, a fixed-income strategist at Credit Agricole SA inLondon. “There’s been a buildup of concern about the economic outlook, fresh doubts about the unity of the European Union, and the Greek rescue package that still needs to be approved. All this is supporting bunds.”

Spain’s 10-year yields climbed 12 basis points this week to 5.12 percent. The extra yield investors demand to hold the 10- year debt instead of their German counterparts reached 312 basis points, the most since the ECB started buying the bonds.

ECB Meeting

ECB policy makers convene on Sept. 8 to review interest rates and are forecast to leave their benchmark at 1.50 percent, according to a Bloomberg survey of 57 economists. ECB President Jean-Claude Trichet will hold a press conference the same day.

“The key thing next week is the bond-buying program,” Green said. “Whether they keep it going, what Trichet says about it, and it will be interesting to see the degree of buying that goes on in the secondary market.”

Greek two-year notes slumped for a sixth week, sending the yields on the securities up to a euro-era record 47.29 percent. The nation’s deepening recession will probably scuttle its 2011 deficit targets and mean no growth next year, the country’s finance minister said, as European Union and International Monetary Fund officials suspended their fifth quarterly review.

German government bonds have handed investors a gain of 5.7 percent this year through yesterday, according to indexes compiled by the European Federation of Financial Analysts Societies and Bloomberg. Greece’s have declined 22 percent, Italy’s have dropped 0.4 percent and Spain’s have increased 4.8 percent, the indexes show.

To contact the reporters on this story: Emma Charlton in London at echarlton1@bloomberg.net; Keith Jenkins in London at kjenkins3@bloomberg.net.

To contact the editor responsible for this story: Keith Campbell at k.campbell@bloomberg.net.