Europe Inflation Barb Gives New Year Bond Fizz a Bitter Taste


The sigh of relief in Europe’s sovereign bond market over cooling inflation may prove short-lived, say strategists from Citigroup Inc. to Societe Generale SA and Danske Bank A/S.

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(Bloomberg) — The sigh of relief in Europe’s sovereign bond market over cooling inflation may prove short-lived, say strategists from Citigroup Inc. to Societe Generale SA and Danske Bank A/S. 

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As nation after nation rolled out lower-than-expected inflation prints through the first week of 2023, the last chunk of data from the euro area itself on Friday carried a bitter detail that served as a reminder European Central Bank officials will most likely make good on the aggressive tightening stance they’ve promised — even as German 10-year bond yields posted their biggest weekly decline on record.

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“This is more of a short covering rally than anything else,” said Charles Diebel, head of fixed income at Mediolanum. “One swallow does not a summer make. I think it’s too early to sit there and say that European inflation has turned the corner.”

Traders are grasping for hints inflation may be easing off after spiraling price growth last year drove government bonds to their biggest annual loss on record.

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The signals finally seemed to arrive last week as the euro area’s headline reading for December came in at a less-than-forecast 9.2%, capping a slew of improved data for individual countries as well as tumbling natural-gas prices.

However, the core measure of inflation — which strips out food and energy — quickened to a record 5.2%, cementing evidence of the underlying pressure that’s kept the ECB hawkish and has analysts pointing to renewed weakness in debt markets.

Citi just revised up its first-quarter German 10-year yield target by 20 basis points to 2.55%. Societe Generale sees the rate approaching 3% at its peak, surpassing the 11-year high set in the latter days of 2022. 

The yield on the German notes ended last week down 11 basis points at 2.21% compared with a peak of 2.57% on Dec. 20. The rally extended after US Treasuries surged on slower-than-anticipated wage data and an unexpectedly weak services-sector indicator on Friday.

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“The New Year rally looks fragile,” Citi strategists including Jamie Searle wrote in a note on Friday. “The market appears to be making the same mistake as late November and early December by placing too much emphasis on falling headline inflation.”

ECB President Christine Lagarde admonished investors last month, warning that the Governing Council would hike more than was then priced in. Policymakers lifted their inflation forecasts last month to an average of 3.4% in 2024 and 2.3% in 2025, still above their 2% target. 

Euro-Zone Inflation’s Sharp Drop Masks Underlying Pressures 

For Chris Jeffrey, head of rates and inflation at Legal and General Investment Management, the headline inflation drop won’t see him loading up on bonds. 

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“These changes in headline CPI I think are just going to be shrugged off,” he said. He’s waiting to see signs of a faltering labor market and higher inflation-adjusted yields before taking a long position in euro-zone government debt. In the coming week, traders will be turning their focus to gauges of industrial production for insight into the economy’s resilience.

While Diebel at Mediolanum said he’s “mildly” positive on government bonds, he’s nonetheless focusing exposure on longer-dated securities such as Austria’s 100-year bond, which he says will be less affected by when exactly the ECB’s key rate peaks. Pressure on shorter maturities looks set to continue for now, he said.

For Oliver Eichmann, head of rates and fixed income, EMEA, at DWS, there may be little chance of a strong rally any time soon, but last year’s slump has created attractive opportunities. 

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“We don’t see a major drop in yields from current levels over the next 12 months,” he said. “There will probably be a lot of volatility and there’s little room for the ECB to relax, but we don’t see a further sell-off here.”

Money-market traders are wagering on around 145 basis points of additional rate hikes from the ECB by the middle of 2023.

After Friday’s latest inflation numbers, policymakers were quick to warn against reading too much into softer headline prints.

Though the latest price data from Europe is “quite positive,” borrowing costs must still be pushed higher, ECB Governing Council Member Mario Centeno said. Chief Economist Philip Lane said the latest data are not conclusive for the inflation dynamic.

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“It may seem like peak hawkishness is behind us and the stagflation may be milder than anticipated, but the ECB is not near its tightening end,” said Piet Christiansen, chief strategist at Danske Bank. 

This Week 

  • Auctions are planned from countries including the UK, Germany, the Netherlands, Italy, Austria and Spain. Syndications could take this week’s volume above €35 billion, according to Commerzbank AG strategists
  • The Bank of England will also restart gilt sales under quantitative tightening, as well as from its financial stability gilt portfolio
  • Gauges of German and euro-area industrial production will give some insight into how resilient sectors have been to the energy crisis. For the UK, monthly GDP figures will be released Friday
  • Investors will also hear from ECB policymakers including Isabel Schnabel, Pablo Hernandez de Cos and Klaas Knot



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