The The The

The ECB will not abide by markets

Bonds
Althea Spinozzi

Senior Fixed Income Strategist, Saxo Bank Group

Summary:  We believe that the market is ahead of itself regarding ECB's interest rate hikes expectations. The ECB will most likely keep open the possibility to become less accommodative if inflation remains sustained. Still, it will discard interest rate hikes until 2023. It means short-term rates might tumble, forcing the EUR lower. Don't be fooled: positive German yields will soon be a reality across the yield curve as the central banks prepare to normalize monetary policy. Italian government bonds' honeymoon is over as market volatility remains sustained. We expect the BTPS-Bund spread to widen before resuming its decennial tightening trend.


This week, the market has advanced interest rate expectations in Europe. Money markets began to price 9bps of ECB tightening for July, sending shockwaves in the European sovereign space. Two-year German yields rose above the ECB deposit rate of -0.5% for the first time since 2015, in a sign that tomorrow Lagarde will lean against a rate hike in 2022. To foster such suspicions were the higher-than-expected inflation numbers released this week which showed a monthly pick up of 0.9% in Germany and Eurozone inflation rising to 5.1% YoY.

Source: Bloomberg and Saxo Group.

The ECB finds itself in a challenging position ahead of tomorrow's monetary policy meeting. On one side, it will want to retain the option open to fighting inflation. On the other hand, it needs to avoid igniting a deeper selloff in rates markets.

Therefore, the central bank is trapped. With the Federal Reserve and the Bank of England advancing with aggressive monetary policies this year, the euro area's yields will also rise. Additionally, the PEPP program is ending in March, pulling even more economic support and applying upward pressure to rates. That would cause a natural tightening of financing conditions in the euro area, which the ECB would want to monitor.

Therefore we’ll probably see Lagarde pushing back against a rate hike this year, disappointing on the market's hawkish expectations. We could witness a contained rally in European sovereigns, which could tumble the EUR.

Don’t be mistaken: ten-year Bund yields might have become a memory already this week. Any hawkish or dovish shift of the ECB will be mostly felt by the front part of the yield curve. However, it's undeniable that the whole German yield curve willsettle above 0% as the ECB gets ready to normalize its monetary policy. 

Source: Bloomberg and Saxo Group.

Italian government bonds’ honeymoon is over.

The celebrations for the re-election of President Mattarella were short-lived. After a modest tightening of the BTP-Bund spread on Monday, the spread resumed rising yesterday. It shows that the performance of Italian government bonds does not depend entirely on the national political situation. At this moment, they are more vulnerable to central banks’ monetary policies.

Because BTPS carry a higher beta than peers, Italian sovereigns will suffer the most as volatility in rates markets increases. Therefore, we remain constructive on our view that the BTPS-Bund spread will widen to 160bps before resuming its tightening decennial trend.

Source: Bloomberg and Saxo Group.

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

Support Centre
For existing clients, please click here to request support via the Support Centre.

Have a question about our products, platforms or services? Visit the Support Centre to find answers for our most frequently asked questions. If you are still unable to locate an answer to your question, you will also find contact details for your local Saxo office to speak with a representative.

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.

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.