(2) European sovereign bond issuances might find a hostile market
This week, Europe will issue a considerable amount of long-term government bonds. Italy will start with selling 10-year Bonds tomorrow. Germany will follow with 15-year Bonds on Wednesday, and France will sell 10-year bonds on Thursday.
It will be crucial to see if bidding metrics are deteriorating for French OATs, which have been tumbling since the beginning of the year but continue to offer negative yields. News regarding slow Covid-19 vaccinations and a surge of infections adds to the threat of a weak auction on Wednesday as the country’s hospitals are treating an unprecedented number of Covid-19 patients. French 10-year OAT yields rose more than 20 basis points since the beginning of the year, and they now offer -0.1%. If they turn positive, they might put further pressure on the ECB, which is already fighting to keep yields from rising.
That said, we believe that demand for Italian sovereigns will show resilience for the simple fact that BTPs continue to offer an attractive yield compared to that of their peers. Additionally, the Draghi effect continues to provide critical support to the country's government bonds. Indeed, since the beginning of the year, yields rose much less since compared to that of other European countries. Ten years BTPs rose only by six basis points YTD compared to more than 20 basis points for France, Germany, Spain and Greece.The European Central Bank’s attempt to keep yields in check by increasing purchases under the Pandemic Emergency Purchase Programme (PEPP) is not proving fruitful. On Friday, as the Treasuries sold off in the United States, European bonds tumbled as well. We believe that the ECB is fighting an uphill battle as it is evident that yields in the United States will continue to rise in the mid-term, and it will be impossible for the central bank to break the positive correlation between the US Treasuries and their European peers. The best the ECB can do is keep the correlation between the two markets as close as possible to zero. Still, it will run into the risk to provoke an exodus from the periphery, which already offers little if no pick up at all over US Treasuries once hedged against the euro.