Eurozone debt rallies as PMI fuels rate cut bets

Eurozone debt rose across the board on Tuesday as a downbeat survey on Germany’s manufacturing and services sector reinforced the case for an interest rate cut by the European Central Bank.

Germany’s private sector shrank for the first time in five months in April, according to a survey, fueling concerns the eurozone crisis was taking a toll on its largest economy.

German Bund futures hit a new contract high, but Spanish government bonds outperformed as a bill auction attracted demand. Italian borrowing costs over 10 years fell below 4 percent for the first time since November 2010.

“We have a weak situation as shown by the PMI (Purchasing Managers’ Index)… the global picture is one of a still- struggling economy. In this context, I think the market is positioning itself for a rate cut by the ECB maybe as soon as next month,” according to Jean Francois Robin, head of strategy at Natixis.

Ten-year Spanish government bond yields fell to their lowest since November 2010 at 4.308 percent.

Spain sold 3-month bills at the lowest yield on record at the auction as investors snapped up the relatively high-yielding paper in anticipation of an ECB rate cut.

Italian yields were 11 basis points lower at 3.98 percent.

“It’s a one-way flow. As soon as an offer shows, it tends to get lifted and the market reprices aggressively quite quickly,” one trader said.

Downbeat data out of Germany also underpinned demand for safe-haven debt, which hit a June contract high of 146.77 earlier, but last stood up 19 ticks at 146.54.

Piet Lammens, strategist at KBC, said the next important technical resistance was the record high hit by the Bund in June at 146.89 or the record low on the German 10-year yield at 1.126 percent hit in July last year.

The yield was last down 1.3 basis points at 1.21 percent.

French 10-year borrowing costs hit a new record low of 1.706 percent as part of the broader move lower in eurozone debt yields, while a survey showing France’s business downturn eased more than expected in April also underpinned its bond prices.

During the three-year-old euro zone debt crisis, German and peripheral yields have tended to trade in opposite directions because investors favored the former when they sought safety in turbulent times and lower-rated debt when they were more open to risk-taking.

That relationship has been eroding in recent months and in particular after the Bank of Japan announced massive stimulus plans which are expected to prompt Japanese investors to switch out of their own bonds into eurozone debt.

“There is a general convergence trade going on across Europe,” one trader said. “It’s all flows-driven and domestic accounts (in Spain and Italy) are extending out along the curve … going longer in duration in the hunt for yield.” [Reuters]

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