* German 2-year bond yields at record low
* Set for biggest monthly fall in four years
* Schatz yield out of sync with broader bond market
* Investors seek short-term bonds as collateral, safe-haven
* Graphic: reut.rs/2mhAOEV
By Dhara Ranasinghe
LONDON, Feb 21 A sudden, steep drop in Germany's
2-year government bond yield to record lows on Tuesday was
loosely linked to French election jitters but has left many
investors puzzling over a move way out of kilter with other
German and European bond market shifts.
Despite a plethora of fundamental and political influences,
strategists suspect sharp declines in the two-year rate are
being amplified by bottlenecks in the European Central Bank's
bond buying programme and some reckon an imminent change in
European collateral rules surrounding securities repurchase
agreements may also be to blame.
The two-year German Schatz yield hit a record low on Tuesday
for a second successive day, falling to around minus 0.87
percent, and flying in the face of reports showing
euro zone private sector and manufacturing business growth
unexpectedly accelerating to near six-year highs in February.
And while investor anxiety ahead of French presidential
elections in April and May has seen some flight to German from
French government debt in recent weeks, the two-year Schatz move
ran counter to a rise in 10-year bund yields on Tuesday.
What's more, the yield drop on Monday and Tuesday also came
in the light of more positive news on Greece's latest government
bailout plan, with international lending monitors expected to
return to Athens this month, and growing speculation about a
rise in U.S. interest rates since March.
"The short end of the German yield curve is now completely
independent from all the macro moves, ECB policy and doesn't
really correlate with the long end of the curve either," said
Peter Schaffrik, head of European rates strategy at RBC Capital
"What I think is driving it is a shortage of the asset
In essence, said analysts, there is a mismatch between
supply and demand in short-dated German debt.
On the supply side, the German government plans to issue 1
billion euros less in two-year debt this year than in 2016.
The high demand stems partly from the European Central Bank,
which is buying German bonds for its asset stimulus programme,
and from investors such as investment funds that need
high-quality debt as collateral to raise money in markets and
guarantee their trading positions.
Investors may also be buying up high-quality government
bonds ahead of new European Union rules coming in next month
that require banks and other investors to hold extra collateral
against intra-day price swings on certain derivative contracts.
A squeeze on short-dated debt, pushing yields down, has been
exacerbated in recent days by heightened investor nervousness
about France's unpredictable presidential race.
Germany is the euro zone's benchmark issuer and its bonds
are regarded as among the safest assets in the world.
While two-year German bond yields have fallen 10 basis
points in just three trading sessions, German one-year treasury
bills and five-year bond yields are down less than half that
over the period. German 10-year debt is down only 2 basis points
in that time and were actually higher on the day on Tuesday.
"The strength in the German Schatz bond suggests this is a
story about a scarcity of German debt and about supply and
demand," Commerzbank rates strategist Rainer Guntermann said.
And with the Schatz yield deeply in negative territory,
investors are willing to pay - rather than be paid by the German
government - to hold German paper.
The plunge in short-term German bond yields is also
reflected in a rare divergence with Eonia money market rates. reut.rs/2mhAOEV
The two have had a close relationship in the past, with both
seen as signals on the outlook for economic growth and monetary
policy. But with the German yields now driven by scarcity
problems, money market rates may offer a better guide to where
markets see ECB policy rates going, analysts said.
"Eonia rates are now a much better guide of where the market
sees ECB policy and the two-year German two-year yield is just
living its own life," RBC's Schaffrik said.
(Graphic by Nigel Stephenson; Editing by Alison Williams)