Inflation optimism drives European sovereign yields lower Inflation optimism drives European sovereign yields lower Inflation optimism drives European sovereign yields lower

Inflation optimism drives European sovereign yields lower

Althea Spinozzi

Head of Fixed Income Strategy

Summary:  As markets are precipitously pricing an aggressive ECB pivot next year, there is no guarantee that core inflation won't remain sticky, causing policymakers to push back on rate cut expectations. As discussions surrounding the end of PEPP reinvestments will begin, it's unlikely that the ECB will pivot before next June unless the recession becomes deeper. As bond futures are pricing for 150 basis points rate cuts next year, the chances are higher for markets to price out rate cuts rather than more. That leaves sovereign bonds at risk of repricing.

While the recent U.S. bond bull market is based on assumptions of a soft landing, the drop in yields we are witnessing in the old continent is driven by expectations of a deep recession, ultimately killing inflation.

To confirm such a notion was the recent speech of Isabel Schnabel, saying that a faster-than-expected slowdown in inflation was a pleasant surprise, evidence that tighter financial conditions are working and that further interest rate hikes might not be needed. That was enough to fuel speculations that the ECB will be the first among G7 countries to cut interest rates as early as April and to be the most aggressive compared to peers, cutting by 150 basis points by year-end. Such expectations fueled an everything rally, with the Stoxx 600 index rising 9% since its October low and German Bund yields dropping to 2.25% from their 2.96% October high.

The problem with the above is that such a rally is based on the notion that inflation is dead and could soon fall below target. Yet, the core Eurozone inflation in the euro area remains at 3.6%, and there are signs that inflation can remain sticky for some time due to wages and the withdrawal of certain support measures, such as price caps and VAT relief.

To better understand when the ECB would likely cut rates, it is essential to consider PEPP reinvestments. Recently, Lagarde said that the PEPP will soon be discussed. That means the earliest date for PEPP reinvestment to end is January 2024. It is unlikely that guidance for rate cuts will come at the following monetary policy meeting unless a deep recession or a tail event presents itself. That makes the first rate cut more likely in June rather than April.

That means markets can push back on expected interest rate cuts, causing sovereign yields to rise again.

Ten-year Bund yields broke below their 50-day simple moving average yesterday. Although they will find support around 2.15%, stronger support will be met at 1.91%. That would be the lowest since March this year, amid the SVB crisis.

Source: Bloomberg.

The Saxo 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 is not intended to and does not change or expand on this. 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 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 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 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 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 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 (
- Full disclaimer (

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.