With many expecting long-yield to continue declining no matter what, and how many hikes, the Fed and central banks do on the short end, Tommi Utoslahti, a former derivatives trader and analyst and currently one of Bloomberg’s Global Macro squawkers, disagrees and as he writes in his latest Markets Live note below, expects a violent repricing in European rates, and especially the Bund market, where "Investors have become so blinded by QE-suppressed ultra-low yields that they risk sleepwalking into a major correction even as most hard indicators scream for heightened alertness." Of course, the ECB is to blame for this:
"The ECB’s capital-key requirement, combined with documented early overbuying in the most liquid euro-zone nations’ bond markets, resulted in the central bank accumulating almost 450 billion euros of German debt by end- November 2017. For that reason alone, German yields remain artificially low, with the curve negative all the way out to seven years. That’s not sustainable."
The current 10-year yield around 0.3% is ridiculously out of whack with economic reality. Investors have become so blinded by QE-suppressed ultra-low yields that they risk sleepwalking into a major correction even as most hard indicators scream for heightened alertness.
The resulting risk: another April 2015 VaR shock event: "As Frankfurt winds down its red-hot printing presses, German economic fundamentals argue for significantly higher bund yields. What everyone from the ECB to the trading floor will want to avoid is a replay of April 2015, when yields went from 0.08% to 0.98% in just seven weeks."
HIs full note below:
Bund Yield to Close Gap With Economic Reality
The conditions are in place for bund yields to head sharply higher in 2018 as the ECB finally steps off the QE stage and the German economy continues to fire on all cylinders.
The current 10-year yield around 0.3% is ridiculously out of whack with economic reality. Investors have become so blinded by QE-suppressed ultra-low yields that they risk sleepwalking into a major correction even as most hard indicators scream for heightened alertness.
Germany is in better shape than at any time since the European debt crisis. For all the official talk about a "continuing recovery," we should be very clear: the "recovery" phase happened in 2013 when the nation’s growth bounced back from a brief contraction. That’s now ancient history.
The German economy has since expanded for 18 consecutive quarters and annual growth is now the fastest since 2011. Unemployment is at the lowest level since the fall of the Berlin Wall and the IFO business climate survey is at a record high. The pan-German inflation rate is back at the central bank’s definition of price stability: "Below, but close to 2%."
This isn’t a recovery. It’s boom time. Providing emergency stimulus to a healthy economy risks severe side-effects.
The ECB’s capital-key requirement, combined with documented early overbuying in the most liquid euro-zone nations’ bond markets, resulted in the central bank accumulating almost 450 billion euros of German debt by end- November 2017. For that reason alone, German yields remain artificially low, with the curve negative all the way out to seven years. That’s not sustainable.
Bloomberg clients agree that the country will see higher yields: the whisper survey forecast for the end-2018 bund yield is 0.61 percent, similar to the 1- year forward rate. The Markets Live team estimates that the yield can comfortably overshoot that level.
Potential catalysts include a surprise inflation pickup (not a stretch given the positive output gap), or an early end to ECB bond purchases and/or negative deposit rates. Also possible is that, in an extension of behavior seen since April 2017, the ECB may buy even less German debt to correct for the previous excess purchases.
As Frankfurt winds down its red-hot printing presses, German economic fundamentals argue for significantly higher bund yields. What everyone from the ECB to the trading floor will want to avoid is a replay of April 2015, when yields went from 0.08% to 0.98% in just seven weeks.