The current environment for long term interest rates in Europe is a very peculiar battle ground between countries which are deemed to be mired in vicious cycles of sovereign debt crunch leading to default and countries which are stable and possibly going to suffer from recessionary and deflationary environment.
Germany is a country which could suffer from the latter. Firstly it is expected the economy will slow down in the 4Q leading potentially to economic contraction in early 2012. At the same time as the European and global economy is slowing down fast European countries will be hit most. The fiscal austerity prescribed by Germany and enforced by frantic downgrade avalanche by rating agencies will definitely worsen the situation. The retrenchment of the governments will greatly impair government spending and investment leading to deeper economic retrenchment.
The current German government bonds are locked in a trading range which seeks resolution. The pattern which is forming can be resolved to the downside if and when the German Bund falls below 133. On the other hand if the German Bund is going to rise above 140 then interest rates on long-term German government bonds may begin a new round of declines. This is the upper level of a well-marked uptrend as shown in the chart. Thus any movement above this level shall be highly significant.
Further decline in German rates could be associated with more equity market risk, more sovereign stress in Europe, continued expectation of deflation particularly in Germany and finally but not lastly stronger expectation of Euro-zone disintegration.
The resolution of the trading range in the German Bund can have an extremely strong indicative character for the things to come.
Source : Bloomberg
