Tame Inflation Comforts Uneasy Bond Markets

  • Euro zone bond yields down
  • Data confirms euro zone inflation slowdown in June
  • Lifts sentiment ahead of Thursday’s ECB meeting
  • But yields holding at higher levels since Draghi Sintra speech
  • Euro zone government bond yields fell on Monday, as tepid inflation numbers lifted expectations of a cautious stance at this week’s European Central Bank meeting.

    The ECB meets on Thursday, three weeks after comments from central bank chief Mario Draghi that were seen as opening the door to policy tweaks in the coming months triggered a jump in bond yields and the euro.

    While borrowing costs remain at elevated levels, weak U.S. data and subdued euro zone inflation have provided some comfort to bond markets, on edge that an era of ultra-loose monetary policy is drawing to a close.

    Data on Monday confirmed that consumer prices in the euro zone rose 1.3 percent year-on-year in June, in line with market expectations and decelerating form 1.4 percent in May.

    The core measure, which strips out unprocessed food and energy, edged up to 1.2 percent on the year but remains low.

    “The inflation data is feeding expectations that Draghi will use Thursday’s press conference to set the tone right about the policy outlook,” said DZ Bank rates strategist Daniel Lenz.

    Bond yields across the bloc fell 2-5 basis points, led by peripheral debt markets .

    Germany’s 10-year bond yield dipped 2 bps to 0.51 percent – down from 18-month highs hit a week ago at 0.58 percent but roughly double the levels it traded at just before Draghi’s speech.

    Commerzbank described the speech as the “beginning of the end” of quantitative easing (QE) in the euro zone, noting that the rise in German yields was in line with the rise seen in U.S. Treasury yields in the weeks after the U.S. Fed signalled an unwinding of its QE programme in May 2013 in what became known as the “taper tantrum”.

    “Judging by the U.S. experience, the further upside in Bund yields would be some 70 basis points over the next couple of months and some 120 bps by the time the ECB starts tapering,” said Christoph Rieger, head of rates and credit research at Commerzbank.

    “Whether this will be realised crucially depends on how the ECB conducts its exit.”

    The ECB may this week drop a reference to its readiness to increase the size or duration of its asset-purchase programme before announcing in the autumn how and when it will start winding down its bond-buying.

    But no major changes are expected and the ECB is likely to wait until September to announce a tapering of its 60 billion euros of monthly asset purchases, probably starting in early 2018, according to Reuters poll.

    “If anything, I think the ECB will be at pains to say this week nothing has changed and actually effectively message to markets that they shouldn’t get ahead of themselves in anticipating a tightening of conditions,” said Mark Dowding, a portfolio manager at BlueBay Asset Management.

    Elsewhere, Greece was also in focus. Amid media speculation of a new Greek government bond deal coming this week, 1.5 billion euros of bonds sold to private investors in 2014 is due to be redeemed on Monday.


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    Dean Popplewell

    Dean Popplewell

    Vice-President of Market Analysis at MarketPulse
    Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
    Dean Popplewell