Eurozone: Post-Sintra pause in rates? - ING

The sell-off in German 10-year Bunds that commenced after Mario Draghi’s speech in Sintra, Portugal, appears to have run out of steam, according to Martin van Vliet, Research Analyst at ING.

Key Quotes

“In fact, 10-year yields have recently slipped back to the 0.50% area – which marked the top end of the range that prevailed in the first six months of this year. ECB rhetoric, including that of the central bank president at the July policy meeting, has clearly turned more cautious, and markets seem to be bracing themselves for a ‘dovish’ ECB taper announcement in the autumn.”

“Moreover, investors have shifted their focus to subdued new bond issuance over the summer, while wading back into riskier carry trades. This is clearly visible in the behaviour of sovereign yield differentials with Germany. We find 10-year Spanish spreads over Bunds trading at the lows seen at the time of the launch of QE in March 2015, despite the growing clash between the Spanish central and Catalan government on the latter’s desire to hold a referendum on independence on 1 October (which indicentally is already leading to higher yields on outstanding Catalan debt). The spread at which Italian bonds trade over Bunds has also narrowed, as if investors have forgotten about the elections that will take place within the next 9 months.”

“We still believe that peripheral spreads, Italian ones in particular, are vulnerable to any sign of real ECB QE tapering. Our fair value estimate for Spanish-Germany 10-year yield spreads, which is based off relative growth and fiscal differences amongst others, suggests that the tightening impact of QE is around 50bp at the moment.”

“While we do not think this will fully disappear after a taper announcement, much will depend on how long the tapering will take. In our view the ECB will be keen to avoid a scenario where investors quickly extrapolate the end of the net asset purchases (hence our house view for a 6 month extension to mid-2018 at a constant albeit lower purchase pace). To credibly signal that QE could be extended further, however, taking into account a scarcity of eligible debt, the ECB would have to tweak the modalities of the PSPP, eg, increase the issue share limit for non-CAC bonds.”

“All in all, the summer calm may well persist until Draghi’s speech at the 24-26 August Jackson Hole Summit, which takes place two weeks before the September ECB meeting.”