Our 2023 outlook for German Bund

Our new scenario sees the European Central Bank (ECB) hiking the deposit rate to 3.5% by the end of May 2023. We also expect a complete halt to Asset Purchase Programme (APP) reinvestments to begin in Q3 2023.

Euro sovereign bond yields were sharply up after the ECB’s December meeting. By signalling its intent to continue hiking to a “significantly higher” level, the ECB risks prompting a more severe and protracted recession. We expect the German yield curve to invert further so long as the economic backdrop deteriorates, and the ECB keeps hiking.

Although the surge in the inflation rate in the euro area and the ECB’s efforts to bring it back to its 2% target by hiking its policy rate aggressively mostly explain the rise of the 10-year Bund yield from -0.18% at the end of last year to 2.29% (on 21December), there also seems to be the build-up of some risk premium at play in part due to the German government’s announcement of large fiscal spending.

This structural shift from net-saver to net-borrower leads us to fear that the Bund’s safe-haven status could be eroded, compounded by an environment of elevated inflation and a hawkish ECB. The 10-year Bund yield may peak at around 3% in the coming months before falling back to2.5% at the end of 2023.