How much bearish momentum is left in German bond market?

Core fixed income suffered another torrid session yesterday with the German curve undergoing a further pronounced bear steepening leaving 10y and 30y yields 7bp and 9bp higher respectively (hitting 0.95% and 1.66%) at the close. The initial trigger for the move looked to be related to US corporate supply with an announcement re. a US$9bn multi-tranche deal from tobacco company Reynolds American Inc at the beginning of Europe's afternoon session steepening the UST curve which saw long end Bund yields rise in sympathy and with the European sell-off then accelerating as the Bund future broke below 150.

Notably, this rise in core yields occurred alongside a pick-up in market based measures of inflation expectations with 10y German breakevens ending 7bp wider at 1.32% (modestly short of the highest close of the yr of 1.35% seen on May 1) while the 5y5y fwd euro inflation swap edged 2.5bp higher to close at 1.815%.

"The rout that kicked off at the beginning of May was the result of an unsustainably large disconnect between liquidity and fundamentals. Furthermore, inflation expectations should be monitered in order to assess the sustainability of any sell-off or rally from here. Going forward, however, the bearish tone in core bonds is likely to lose momentum. In part, this is owing to the fact that inflation expectations have, by some measures, largely reversed the softness seen in the wake of the sharp drop in commodity prices seen in the latter half of last yr", argues Rabobank.