LONDON: Short-dated German government bond yields set a new record low and were on track for their biggest two-week fall in more than three years on Friday, highlighting demand for top-rated assets even as global bond markets take a beating.
Demand for German debt for use as collateral for short-term lending in repo markets has helped drive two-year bond yields lower this week.
Jitters ahead of an Italian referendum on Dec. 4 have also bolstered demand for German bonds, regarded as among the safest assets in the world. Germany's two-year Schatz yield fell to a record low of minus 0.75 percent. It was on track for its biggest two-week drop since July 2013 with a fall of 14 basis points.
The European Central Bank's 1.7 trillion euro bond buying stimulus scheme has made it hard for investment funds to source high-quality collateral to use for borrowing in so called repurchase-agreements, or repos, putting downward pressure on yields.
The ECB now owns 273 billion euros of German paper, according to Societe Generale.
ECB sources told Reuters this week the central bank would act to address bond scarcity issues in the repo market, helping push yields briefly higher.
ECB Vice President Vitor Constancio added on Thursday that euro zone central banks can lend out more of the bonds they have bought as part of the ECB's stimulus programme to support the market for short-term funding.
But analysts said scepticism about any long-term relief for the repo market had set in, pushing two-years back to record lows.
"Markets don't believe that any steps the ECB takes will be enough to alleviate a squeeze in the repo market," said Rene Albrecht, a rates strategist at DZ Bank.
A freeze in repo lending risks undoing some of the ECB's stimulus by hampering lending between financial companies and leaving bond markets vulnerable to sharp selloffs. Commerzbank rates strategist Michael Leister said the issue of strain in the repo market was unlikely to fade.
"Tweaking the securities lending programme is not enough, substantial changes are needed and we think that's unlikely because national central banks take another view to the ECB."
The fall in German two-year bond yields adds to the divergence with US peers, which are trading near their highest levels since 2010 as investors bet on economic strength and an expansionary fiscal policy under US president-elect Donald Trump driving up inflation and interest rates.
In fact, the gap between two-year bond yields in the US and Germany on Friday stood at around 190 bps -- its widest since 2005.
The gap between five-year bond yields , another big mover this week, was at around 229 bps and near its widest since at least the early 1990s.
Euro zone bonds yields were 2-4 bps lower on the day in generally subdued trade due to the US Thanksgiving holiday.
They have been supported this week by the notion that the ECB will maintain its ultra-loose monetary policy for some time.
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