Euro area rates: Weekly review

This time around the supply/demand mismatch effect might stay relevant going into any QE expansion announcement from the ECB, keeping Bund yields supported. Post the QE expansion announcement, some reflationary effect will likely come into play, especially if risky assets and oil prices are doing well. 

"We recommend closing longs in 5y EONIA and France, but we maintain outright long 5y Spain. In EGB spreads, we continue to recommend 10y core periphery and 5y5y fwd France tighteners versus Germany", says Barclays.

Markets have been in risk-on mode since payrolls with stocks on both sides of the Atlantic rallying by 3-4%, oil prices rebounding by about 8%, EM assets rallying and DM bonds selling-off. 10y Bund, Treasury and Gilts have all sold off about 7-10bp on the week despite the fact that both German industrial production and factory orders data were notably weak. 

Regarding the duration outlook for German rates, ECB and BoJ might impact 10y and longer Bund yields on a macro level depending on risky asset and oil price reaction. In the past week, there have been tentative signs that risky assets and oil prices are reacting constructively; however, it is still too early to be conclusive on this. 

The other important factor for the duration outlook will be what further potential easing from the ECB means for longer German rates. The ECB has two main channels to provide more accommodation: by making the existing QE programme more expansive, and/or introducing the deposit rate cut possibility.