2022.12.18 07:27
Budrigantrade.com-ECB and bond market
Budrigantrade.com – European bondholders are adjusting to the possibility that this year’s devastating losses will continue into 2023.
After a chorus of central bankers warned investors that interest rates will rise more than anticipated, one of the most brutal sell-offs in months is concluding the region’s worst-ever year for bonds. A new wave of selling appears to be coming, with traders betting on another 130 basis points of hikes versus the Federal Reserve’s barely a half-point increase.
After being regarded for a long time as one of the most dovish central banks in the world, policymakers at the European Central Bank have recently made it abundantly clear that they will not tolerate double-digit inflation. That comes as a surprise to traders who had invested in the battered assets of the region with a false sense of security in light of hints that inflation was reaching its peak.
Ralf Preusser, global head of rates strategy at Bank of America Securities, stated, “It’s a lot less controversial now to not only see European yields reset higher in absolute terms, but we also see European rates markets underperform the US very meaningfully throughout the entirety of 2023.”
When the ECB has issued warnings, the market has acted quickly. Investors have increased their wagers for a peak rate to 3.30 percent since the meeting on Thursday. The worst weekly selloff since June has occurred as a result of an increase of more than 40 basis points in the yield on 10-year Italian bonds, which are among the most sensitive to tighter financial conditions. Germany’s two-year note contacted 2.50%, its most elevated beginning around 2008.
The ECB’s much-improved inflation forecasts were at the heart of its support for higher rates. Shopper costs posted the main log jam in 1 1/2 years last month, declining to 10.1% last month from a record 10.6%, however are as yet seen averaging 3.4% in 2024 and 2.3% in 2025. 2% is the ECB’s goal.
The managers of the region’s government debt, who are still reeling from what is almost certain to be the worst year ever, are dealt a blow by this. This year, the sector’s Bloomberg index has lost 15.5%, the most it has ever lost.
Deutsche Bank AG and UBS Group AG’s recommendations to position for European yields to rise closer to US peers have been strengthened by the ECB’s uncompromising tone. The gap between German and US 10-year yields has narrowed the most since March 2020 in the past week.
There is some skepticism regarding the ECB’s ability to implement the promised level of tightening, despite the sharp repricing seen thus far. This is due to the fact that rising borrowing costs may cause the region to enter a deeper recession, adding to the harm caused by the energy crisis brought on by Russia’s invasion of Ukraine.
Higher financing costs all at once of expanded government security issuance could “trigger a market revolt,” said Guillermo Felices, worldwide venture planner at PGIM Fixed Pay. ” The ECB’s credibility could be harmed by a swift retreat as a result of that conflict.
The impact on Italy, which was at the center of the most recent bond rout, is of particular concern. A global recession is expected in 2023 as central banks continue to hike. One of Europe’s most indebted economies, the country has benefited greatly from the ECB’s bond-buying stimulus and incredibly loose monetary policy.
In April 2020, the nation’s yield premium over Germany, a gauge of regional risk, experienced its largest weekly increase since the beginning of the pandemic.
Mohit Kumar, a rates strategist at Jefferies International, stated, “Overly aggressive monetary policy risks engineering a sharper recession and widening of peripheral spreads, which will raise fragmentation risks.” In her efforts to announce a second half-point increase in February, ECB President Christine Lagarde may have “gone a bit overboard.”
Bond
However, there are numerous other reasons to remain cautious regarding the bond market’s performance in the beginning of the coming year.
A pillar of support from the market was removed sooner than some had anticipated when the ECB announced a much-anticipated plan to reduce its vast debt holdings from the crisis. Francois Villeroy de Galhau, a member of the Governing Council, claims that the central bank will allow bonds to mature at a rate of €15 billion per month beginning in March, potentially increasing that rate by the end of the second quarter.
As governments increase bond issuance to finance programs to safeguard their citizens from punitive energy prices and a cost-of-living crisis, this will increase the net bond supply. That supply pressure, missing in the US, is one more motivation to lean toward Depositories over European obligation, expressed Bank of America’s Preusser.
If reinvestments end in July or September at the latest, BNP Paribas SA strategists anticipate that net European government bond supply will reach €228 billion ($242 billion) in the first quarter and €557 billion in 2023 as a whole.
“What the market had failed to comprehend and price in is that tighter monetary policy is required for fiscal loosening in response to high energy prices. 10% is inflation. Ostrum Asset Management global strategist Axel Botte stated, “Deposit rates have a long way to go.” With the hawks winning, it is a wake-up call.
