Bund yields will rise regardless of the ECB’s monetary policies
Although the bond market is complacent with Lagarde's message today, we believe that the ECB will have a tough time keeping European rates in check during the last part of the year. We identify two main catalysts that will contribute to higher rates:
(1) German elections. As per the latest polls, the SPD is leading the CSU/CDU party. Although the greens have lost some support recently, it looks they could be still part of the next government. That should translate into more Fiscal spending, hence more Bund issuance that will push yields higher.
(2) Positive correlation with the US Treasuries. We expect yields to rise in the US and drift yields higher in Europe, too. On one side, if an agreement over the debt ceiling is not reached soon, it will increase the risk of a Quantitative Tightening (QT) in October /November. Indeed, the later a decision is taken, the larger the volumes of Bills the US Treasury will need to issue in a short time to refinance existing debt by the beginning of November. On the other hand, the longer the Federal Reserve delays tapering, the more aggressive it will need to be, provoking a fast rise in yields.
We expect 10-year Bunds to break above 0% by year-end and stabilizing around 0.2%. As a consequence, European Government bonds will need to reprice accordingly. We are particularly bearish Greece, France, Portugal and Spain. We remain neutral on Italian BTPS as we see still scope for the BTPS/Bund Spread to tighten to 75bps by the end of the year. However, it doesn't mean that yields won't rise in Italy, too. We expect them to stabilize between 0.9% to 1%.
Where does that leave us?
We remain of the idea that this is a golden opportunity to take advantage of cheaper valuations to short the bond market, as we have outlined in our recent piece.
Euro-Bund put-options with December expiry, 169 strike and Delta 20 have cheapened considerably and are now pricing at 0.360 while on Tuesday were trading at 0.470.
If you are not comfortable with put options, you can look at ETFs shorting European sovereigns such as:
- Lyxor Bund Future Daily (-1x) ETF (BUNS:xpar)
- Lyxor Bund Daily (-2x) Inverse UCITS ETG (DSB:xpar; LYQK:xetr)
- Lyxor BTP Daily -2x Inverse ETF (BTP2S:xmil)
- Lyxor BTP Monthly -2x Inverse ETF (BTP1S:xmil)