Eurozone bonds open 2016 on firm ground thanks to safe-haven bid


Investors clamoured for eurozone government bonds when markets opened for 2016 on Monday with tensions in the Middle East and a sell-off in Chinese stocks driving demand for safe-haven debt.

Yields on 10-year bonds were 2-9 basis points lower across the region, and short-dated German government bond yields fell to their lowest in about two weeks.

European stocks tumbled more than 2 percent, with Chinese shares slumping 7 percent on news that Chinese factory activity contracted for a 10th straight month in December.

Heightened tensions between Iran and Saudi Arabia encouraged investors to seek safety in bond markets.

Saudi Arabia, the world's biggest oil exporter, cut diplomatic ties with Iran on Sunday in response to the storming of its embassy in Tehran. Tensions between the two escalated after Riyadh's execution of a top Shia cleric at the weekend.

"All in all, the moves are still reasonably modest and markets are not sure what to make of this tension in the Middle East and whether it will escalate," said KBC strategist Piet Lammens.

A resumption of the European Central Bank's bond-buying programme on Monday after a temporary pause for the Christmas break was seen supporting euro zone bonds.

The yield on two-year German bonds dipped to a two-week low of -0.356 percent. German five-year bond yields also fell to a two-week low at -0.082 percent while 10-year yields fell 6.4 bps to 0.57 percent.

U.S. Treasury yields were also lower, with 10-year yields down 4.8 bps at 2.22 percent.

Analysts said an outperformance of German bonds against U.S. peers may be explained by developments in currency markets that were refocusing attention on low inflation in the euro zone.

A firm euro, which rose 0.5 percent against the dollar on Monday, helps dampen inflation in the euro zone.

China's central bank meanwhile set the guidance rate for the yuan at a more than 4-1/2 year low on Monday.

A weaker Chinese currency lowers the value of Chinese imports and adds to the deflation risks in the euro zone, where the ECB last year embarked on aggressive monetary stimulus to meet an inflation target of close to 2 percent.

"The fact that the euro is strengthening suggests global disinflationary pressures seem more acute in Europe," said Richard McGuire, senior fixed income strategist at Rabobank.

"The weakening of the yuan points to the U.S importing deflation as Chinese imports are cheaper and in Europe, because the euro is strengthening versus the dollar as the yuan is weakening against the dollar, the impact is magnified," he said.

German annual inflation stayed at ultra-low levels in December, preliminary state data indicated on Monday. A flash estimate of December euro zone inflation is due out on Tuesday.

Elsewhere, bonds from Catalonia showed little reaction to the prospect of new elections in the Spanish region after a far-left party on Sunday voted against supporting nationalist regional President Artur Mas for re-election.