New Lows for European Bonds

Southern European government bond yields hit new lows as the promise of fiscal stimulus in the United States added to a heady cocktail that already included unprecedented central bank support and confidence in a European Union recovery fund. Though talks between the U.S. Republicans and Democrats were suspended last week, markets retain hopes of a breakthrough, with the U.S. dollar holding on to overnight gains against a basket of currencies. In quiet summer trading, Spanish and Portuguese borrowing costs dropped to new five-month lows while benchmark Italian 10-year bond yields remain below the 1% mark.

Absence of significant data releases or Europe-related headlines to disrupt the mood, the recently agreed European recovery fund has encouraged investors to keep buying this kind of debt. Central bank liquidity flooding the system is also pushing spreads tighter. Difference between three-month Euribor and the Euro Overnight Index Average, has gone negative for the first time since early March. In the UK, the difference between two and 10-year gilt yields were close to their lowest level since March as the outlook for the British economy remains uncertain, with the country suffering its worst job losses since 2009.

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