Pessimism around economic growth takes toll on German bond yields

Germany's long-dated government bond yields were just a whisker away from their lowest levels in over two years on Friday, a sign of the depth of pessimism about the world economy gripping financial markets.

At just 0.15 per cent, 10-year bond yields in Germany have this week taken a step closer towards zero per cent -- levels last seen in 2016 when the European Central Bank expanded its monetary policy stimulus scheme to stave off the threat of deflation. Data on Friday showing factory activity shrank across much of Asia in January added to worries that trade tariffs and cooling demand in China pose an increasing threat to global growth.

The U.S. Federal Reserve on Wednesday signalled that its three-year interest rate hiking campaign may be at an end given a cloudy economic outlook. And in the euro zone, data on Thursday confirmed Italy slipped into recession at the end of 2018 and Bundesbank President Jens Weidmann said Germany's economic slump will be longer than earlier thought.

As investors bet that central banks have little option but to pump more stimulus into the economy, fixed income markets remain in favour with investors. "There has been a changing expectation of Fed policy, which was confirmed this week, while there is a view in the eurozone that rates will stay lower for longer," said Zoeb Sachee at Citi, adding that this tone had shaped bond markets at the start of the year.

"If growth continues to be weak, oil prices stay low, then there is a worry that a deflationary impulse will return and markets fear that the ECB will struggle to fight that," he said. On Friday, most eurozone bonds yields were largely steady after another week of sharp falls. French and German 10-year bond yields are down about 5 basis points each this week, the second week of steep declines.

Indeed, even news of progress in high-level talks between the United States and China on trade failed to dent bond markets. Spain's 10-year bond yields were set for their fourth week of falls, down about 4 bps, although steady in early trade at 1.20 per cent. Focus shifts to U.S. non-farm payrolls data later in the day for the clues on the U.S. economic outlook.

(With inputs from agencies.)