Ok, so this is worth noting.
Recent richening in the German front end is alarming – and that’s putting it mildly.
While in the longer-run, ECB/Bundesbank QE is likely to drive Schatz yields lower, it’s conceivable Draghi will try to contain this in the near-term. It’s also looking likely that we could see some flattening via the long-end both at home and in overseas havens if Trump doesn’t deliver tomorrow night and sparks a subsequent flight to safety.
With that in mind, consider the following just out from BofAML.
Via BofAML
If the Bundesbank were to become concerned about the low level of bond yields in the front-end and in order to alleviate repo richness and collateral scarcity, it could temporarily reduce its sub-5y purchases (either by shifting back to the >5y sector, which our rates team thinks could be done for a period of up to 2 months, or by temporarily reducing German QE purchases, diverging slightly from capital keys). This would allow 1- 5y to stabilize/selloff somewhat, all else equal. The ECB could also introduce debt certificates to alleviate the ongoing shortage of high quality assets.
In the long-end, flattening risks could also come from a potential US rates rally with a re-pricing of Fed expectations in case Trump’s tax plan disappoints. Indeed, the two most correlated points now between US and EUR are 2y USTs and 30y Bunds. This should push European curves flatter.
