Bond Traders Add to German Short Bets Before Rates Rise Further

(Bloomberg) -- Bond traders are girding for the fallout from the region’s economic recovery by buying protection against rising German yields.

As bunds slumped this week, investors piled into new short positions using 10-year futures contracts. Longest-maturity bonds bore the brunt of the adjustment, with traders hedging their exposure to securities most exposed to higher interest rates.

The spike in so-called open interest -- which has jumped almost 50% since March last year -- shows the market is now positioning for the economy to recover quicker than expected from the pandemic, threatening a 20-year bull run.

“The current environment is all about hedging duration risks, and the instrument of choice with most liquidity is bund futures,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG.

Accelerating vaccine rollouts across the continent are also spurring expectations that the European Central Bank will begin to pare back some of the unprecedented monetary support, removing a key pillar of support.

New outstanding positions in bund futures are recorded from the aggressor side of trade, so market direction and the change in each contract can provide an indication of direction. In this case, fresh positioning increased alongside a rise in yields, which suggests futures contracts were sold.

The dynamic is a stark contrast with Italy, where open interest has held steady despite benchmark yields almost tripling since February.

“Investors see less of a near-term need to hedge BTP credit risks,” said Rieger, citing political stability in Italy that followed the appointment of former ECB President Mario Draghi as prime minister in February, fiscal support from the EU’s recovery fund and accommodative monetary policy.

For some, a paradigm shift is underway in Germany, where most yields have been negative since August 2019 as inflation remained well below target.

NatWest Markets are calling for investors to sell bunds, hailing the end of the “supercycle” that has seen the securities rally for the best part of two decades. Goldman Sachs Group Inc. and ING Groep NV are among banks who see yields rising to 0% by the end of the year.

Germany’s 10-year yield rose one basis point to minus 0.1% as of 9:24 a.m. in London, nearing the highest level since May 2019. The yield on Italian peers fell one basis point to 1.11%, holding close to a 10-month high.

A New Era of Short Bets Against German Bonds Is Beginning

“German bonds are the new kid in town for insurance purposes given markets believe that the next reopening impulse will come from Europe,” said Rishi Mishra, an analyst at Futures First.

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