Persistently uncertain interest rate environment is driving up Pfandbrief yields

As expected, the ECB subsequently raised its key interest rate by another 25 basis points to 2.5% at its September meeting, marking yet another increase this year. Upward revisions to its inflation forecasts, together with a hawkish tone in accompanying ECB statements, have increased the likelihood that the ECB will raise rates at least once more before the end of the year. Additional pressure, particularly in the longer maturity segment, has emerged in recent weeks from growing concerns about a resurgence of the sovereign debt crisis.

In this environment, EUR swap yields have risen sharply since the beginning of July. The 5-year EUR swap yield increased by 75 basis points to 3.49%. Over the same period, Pfandbrief spreads remained stable, as measured by the Benchmark Index iBoxx EUR Germany Covered 5-7, and even tightened by 4 basis points. Pfandbriefe thus reaffirmed their characteristics as a typical rates product and their comparatively low volatility. The iBoxx EUR Germany Covered 5-7 Index is now yielding 3.69%. This attractive yield level is likely one of the reasons for the continued strong investor demand following the summer break.

Pfandbriefe also performed largely in line with German Bund yields. As a result, the relative value advantage of Pfandbriefe, at 33 basis points, has remained almost unchanged over the course of the year. At the same time, however, it continues to stand at a historically low level.

The further development of the conflicts in the Middle East, and the associated pressure on energy prices, is likely to remain a key driver of yield developments in the fixed income market in the months ahead.