The ECB is looking forward to the German elections, and the bond market too The ECB is looking forward to the German elections, and the bond market too The ECB is looking forward to the German elections, and the bond market too

The ECB is looking forward to the German elections, and the bond market too

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  The message from the European Central Bank is clear: expect status quo until the German election. European sovereigns will chase the trend of US Treasuries until fall. Then, higher fiscal spending and better European integration will inevitably push Bund yields into positive territory. Expect risk premia to squash across European government bonds in the long term as we head towards a better European monetary union.


The market quickly categorized yesterday’s European Central Bank meeting as a "non-event". Yet, I believe that at the press conference, Lagarde transpired a crucial point: the ECB won't change its accommodative stance at least until Autumn. Guess what's coming in the fall? The German elections.

The recovery fund is not the only European program that the German constitutional court challenges. The pandemic emergency purchase program (PEPP) is facing a legal challenge questioning its legality entirely. Although this claim is overshadowed by news concerning delays in the Recovery Fund, the legal challenge against the PEPP it's macroeconomically more important. The PEPP has funded European countries' fiscal stimulus packages amid the Covid-19 pandemic. Without it, financing conditions would inevitably tighten, posing an insurmountable threat to the euro system.

The German elections bring about two critical topics: fiscal spending and European integration. We believe that whatever coalition will be formed will lead to either more fiscal expenditure or better European integration, or a mix of the two. The austerity scenario remains a threat, but it is improbable. A CDU/CSU/Green coalition will favour public investment and European integration. It will lead to a better monetary union and squashing risk premia among European sovereigns in the long run.

US Treasuries will dictate sentiment in European sovereigns until the fall

US Treasuries will fill the vacuum that the German election brings to the European sovereign space until fall. We have recently seen 10-year US Treasury yields retracing to levels observed more than a month ago. Yet, we believe that as the macroeconomic backdrop strengthens as the economy reopens, we will see yields pointing higher.

Since mid-march, 10-year Treasury yields have been falling together with their relative strength index (RSI). If they descent to test their support line at 1.50%, and the RSI falls below 40, they may fall even further. However, we exclude yields will break below 1.40% unless there is an endogenous event that forces the market into safe-haven mode. On the other hand, if they break above 1.60% they will enter into bullish territory, leading them quickly to 2%.

Source: Bloomberg and Saxo Bank.

The direction of US Treasuries is even more evident in bond futures. Below you find a chart of the continuous contract of 10-year US Treasury futures. It tells us that it will be hard for Treasury futures to break above the 133 level (around 1.40%), making a downward trend even more probable.

Source: Saxo Bank.

Another selloff in US Treasuries will provoke European yields to soar because despite the ECB being committed to keeping financing conditions stable, the correlation between US and European sovereigns continues to be positive. We believe that Bund yields are likely to move higher to test their resistance line at -0.20%, and if they break that level, they will most likely rise to 0.15%. There is also the chance that yields break below their ascending trendline to fall as low as -0.40%; however, the rally will be short-lived.

Source: Bloomberg and Saxo Group.

Prepare for positive bund yields in the long-term

An increase in public investment will most likely contribute to a realignment of sovereign bond yields in the euro area. Indeed, suppose the German government will be looking to increase spending. In that case, it will need to issue more Bunds, hence contributing to higher yields. Bund yields are negative because the European Central bank has bought more than the new debt issued by the country. The scarcity of collateral is a substantial macroeconomic threat because, without more Bunds, the ECB has limited power to intervene when financing conditions tighten.

At the same time, a German government looking for comprehensive European integration will also contribute to higher bund yields. As soon as Mario Draghi entered Italian politics, he highlighted the desperate need for a common EU budget, which will enable greater fiscal spending at the European level.  A common EU budget would reduce economic disparities among EU countries, contributing to a tightening of sovereign spreads versus the safe-haven Bund. Risk perception of European sovereigns will level out, provoking divesting Bunds and investing in other European government bonds.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992