LONDON, Jan 5 – A 150 billion euro (USD 165 billion) deluge of government bond sales in January is fueling unease in euro area bond markets, a foretaste of a potentially record amount of public debt that markets will have to absorb this year.
Bond yields, which move inversely to prices, have started 2024 higher after plunging in November and December. Germany’s 10-year yield, the eurozone benchmark, has risen to just over 2% from a one-year low of 1.896% last week.
A trimming of investor bets on how much and how early central banks will cut interest rates this year has driven the bond selloff. Now adding to it, are concerns that markets will struggle to digest another year of hefty government debt sales.
ING estimates that the euro area will issue around 150 billion euros of debt this month alone as governments seek to take advantage of the recent yield fall and investors look for new-year opportunities. There is 72 billion euros of net supply when redemptions are factored in.
Inflation has driven eurozone states to increase welfare payments and public sector wages, while higher borrowing costs are adding to their interest bills, keeping debt issuance high.
A similar amount of debt was issued in January last year, but it’s now coming after a powerful rally that looks like it’s nearing an end, said Societe Generale interest rates strategist Jorge Garayo.
“The current (yield) levels, they look difficult for the market to digest the amount of supply that is going to be coming,” he said. “For us, supply will be a worry and should have an upward impact on yields.”
Michael Weidner, co-head of global fixed income at Lazard Asset Management, said one concern is that governments plan to issue a large amount of longer-dated debt.
Longer-dated bonds are generally viewed as more risky, so investors typically demand a premium to hold them.
“We believe there will be more issuance in (longer-dated bonds), and how much duration the market’s ready to absorb is a bit of a question mark given the level of yields,” said Weidner.
Germany plans to issue 10-year bonds this month, and Spain has already sold a 30-year maturity.
Adding to investors’ worries is the fact that the European Central Bank (ECB), a hoover of government debt over the last decade, is extricating itself from the market.
The ECB announced in December it would start to reduce its 1.7 trillion euro pandemic-era bond purchase program – PEPP – by 7.5 billion euros a month in the second half 2024. It is already winding down another of its asset purchase schemes.
When so-called quantitative tightening is taken into account, markets could have to absorb a record 675 billion euros of government debt this year, Barclays estimates, up 25 billion euros on last year.
Weidner said he expects the gap between Italian and German bond yields DE10IT10=RR to widen as Germany tries to bear down on its debt levels and the ECB, which has been a crutch for Italian bonds, steps out of the market.
At around 168 basis points, that spread has widened roughly 10 bps over the past week but was still below peaks seen in recent years.
Not everyone is concerned. Joost van Leenders, senior investment strategist at Van Lanschot Kempen, said inflation and central banks will continue to drive bond markets.
“The economic and inflation cycles tend to be far more important than concerns about bond issuance,” he said. “Bond yields have fallen because inflation has fallen.”
Governments will still be able to issue debt, said RBC Capital Markets’ chief European macro strategist Peter Schaffrik, especially as they also plan to redeem plenty of bonds, returning money to investors.
“I don’t think there will be any failed auctions or anything like that, it’s just a question of the yield concession that the market demands.”
(Reporting by Harry Robertson; Editing by Dhara Ranasinghe and Toby Chopra)