European sovereigns remain at the mercy of US Treasuries until fall
The message of last week’s European Central Bank meeting was clear: status quo until the German elections. It means that European government bonds will remain vulnerable to changes in US Treasury yields from now until fall. It is something that the ECB shouldn't be pleased with since US yields will most likely resume their rise, pushing the cost of funding higher in Europe too.
We believe that increased purchases under the PEPP framework have proved useless. Indeed, the correlation between EU sovereigns and the US safe-havens remains intact. The ECB needs to substantially increase purchases under this program if it wants to keep yields stable in the euro area. In our opinion, the reluctance of the ECB to increase firepower under this program shows a vital concern regarding uncertainties surrounding the German election. Additionally, collateral scarcity remains an issue for the ECB has been buying more bunds than issued starting from the Covid-19 Pandemic.
Bond investors should prepare for higher yields in Europe. A correction will be most felt in those countries where bond yields continue to be close to zero or negative, such as Germany and France. Ten-year Bund yields remain capped by their resistance at -0.2%. However, if this is broken, they might rise fast to try residence at -0.15%, leading them to a fast track to 0%.
This week Italy is issuing 10-year BTPs; we do not expect volatility surrounding this auction. Yet, it will be essential to see if any weakness in bidding metrics is observed.