There have been some interesting developments during the last few days. First, sovereign yields for Spain and Italy exploded. Euro outflows have remained strong (mainly towards Swiss francs). And the EONIA swap rate (the swap used to transform overnight interbank borrowing into a fixed loan) curve has increased:

This increase is quite evident even in very short maturities and, in my opinion, is the main driver of the corresponding increase in German Bund yields. Furthermore, it looks like a part of the German bund liquidity premium (for cash holders looking for a risk-free asset) has decreased with the spread to EONIA swap minimizing:

The open question is if the market is now projecting higher interest rates in the future. Since the current rates are a consequence of excess liquidity (the ECB MRO rate is still 1%), this could also be a result of liquidity hoarding and capital flight (to other currencies). In recent weeks, the MRO share of total ECB liquidity has increased substainsally (from 2.6% to 10% with this week’s MRO being even larger, although a large part has been ELA repayment which carries even higher rates) pushing the interbank rate up since the MRO is weekly and the lending rates are paid on operation maturity. It’s possible that this increase in liquidity is considered permanent by the market (especially if it cocerns capital flight) and, absent a new long-term LTRO, a higher borrowing rate is required in order to be able to repay the MROs.

The fact that even the Swiss 5Y yield has turned negative (with all of the movement occuring within the last few days) points to capital flight as a (at least partial) reason: