DE30: Yield seekers push govt bond spreads down in Europe

8:50 AM 25 June 2019

Summary:

  • European stock markets open lower due to risks related to Iran
  • DAX (DE30) trades close to its critical technical level
  • Yield seekers have pushed risk premia in Europe down

The start to Tuesday’s trading in Europe has not been positive as investors are digesting the latest remarks expressed by Iran after the country was hit (new sanctions) by the United States on Monday. Although these sanctions are personal hence they will have rather a negligible effect on the economy, this could be a stirring of the ongoing geopolitical conflict between the two countries. That’s been the way how markets have read this - stocks in Asian fell, gold prices jumped and Treasuries rallied. The trends seen during Asian hours trading are also visible in Europe with major indices being roughly 0.3% down.

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A substantial compression of risk premium has taken place since the start of the year in the Eurozone. Source: Bloomberg

The increased demand of less risky assets has also been reflected by the new all-time low in the German 10Y yield which has slipped below -0.33%. Being here one needs to mention one particularly important thing. Namely, since the beginning of the year we have seen a notable compression of bond yield spreads to the German bund as evidenced by the chart above (the yellow rectangle presents a comparison of current spreads to the average spread since the start of 2019). As we may notice only spreads in Finland and the Netherlands have not narrowed but the difference is not particularly relevant. What could be important in the future is the fact that some southern Europe countries such as Greece, Portugal or Italy have seen a significant decrease in risk borrowing costs despite their inflated debt levels (keep in mind that Italy has faced an excessive debt procedure earlier this year). The above-mentioned compression means that investors have been buying bonds issued by Italian or Greece governments despite risks built in there. The reason behind such behaviour is simple - a hunt for yields in the environment of relentlessly squeezing yields in core European countries.

The DE30 is still trading above the key support of 12 200 points, hence from this point of view buyers do not seem to be doomed to failure yet. However, the move below this line could be the onset of a deeper pullback even towards the levels nearby 11 600 points. Source: xStation5

Looking into the DE30 breakdown one may notice quite a widespread underperformance of stocks. The interesting story concerns Volkswagen which is gearing up for a Traton IPO (this is a VW truck unit). Namely, according to Bankhaus Metzler analyst Juergen Pieper a valuation of VW based on the sum of all parts approach could be more than twice the current market value. He expects the successful Traton IPO taking into account quite a moderate valuation of the unit. Having assumed a steady increase of the business Pieper has set the price target for VW at 250 EUR, implying a stunning 70% increase.

A majority of stocks trade lower in early European trading on Tuesday. Source: Bloomberg

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