How Europe’s Third Virus Wave Is Playing Out in Markets

Lockdowns, a third wave of infections and a disastrous vaccination campaign: the pandemic is taking a renewed toll on Europe.

And it’s playing out in markets. From bond yields to stock prices, investors are pricing in the potential for months of lost productivity and consumer spending. Options traders are at their most bearish on the euro since July, and the gap between German and U.S. 10-year yields is the widest in a year.

At the heart of the issue is that Europe is failing to combat the pandemic, while the U.S. is on track for normal life to return within months. Just this week, while infighting continued between European Union governments, President Joe Biden was doubling the goal for vaccinations in his first 100 days in office. No wonder investors like Luke Hickmore are bypassing the euro area on their way to the U.S. and the U.K. instead.

“This is entirely due to the delay happening in Europe right now,” said Hickmore, a money manager at Aberdeen Standard Investments. “I can’t see any action by Europe stopping the vaccine juggernaut in the U.S.”

Here’s a reality check on Europe’s markets:

Splitting Yields

The clearest way to see the U.S. and European divergence is via the bond market. Treasuries are pricing in faster economic growth, while German bonds reflect demand for the safest debt and heavy central bank support -- causing the yield gap to widen to 200 basis points.

How Europe’s Third Virus Wave Is Playing Out in Markets

“It reflects the abject failure on part of the EU and remarkable determination on part of the U.S.,” said Rishi Mishra, an analyst at Futures First. For Europe, “it’s the bond market version of taking the elevator down and the stairs up.”

Euro Doldrums

Option traders are now seeing a weaker euro for the remainder of the year, with one-year risk reversals moving in favor of puts.

The currency had surged last year on optimism over the EU’s recovery fund and joint efforts to fight the pandemic. Now, there are concerns that the fund will be delayed, while the U.S. unleashes massive economic stimulus.

How Europe’s Third Virus Wave Is Playing Out in Markets

“The dramatic divergence of European and U.S. growth expectations is a legacy of poor management on this side of the Atlantic and will leave scars in market pricing,” wrote Kit Juckes, a strategist at Societe Generale SA.

Stock Rotation

The rotation in European stocks has started going in reverse, favoring defensive over cyclical. Tech companies in the Stoxx 600 Index capped their best five days since November, while retail and energy retreated during the week. Travel shares that skyrocketed this year on hopes of summer travel returning are now stalling.

How Europe’s Third Virus Wave Is Playing Out in Markets

“The tourism season is a big downside risk to our forecasts” for Europe, Merrill Lynch economist Ruben Segura-Cayuela wrote in a note on Friday. “For a bullish story, we really need to continue looking across the Atlantic.”

What’s happening this week:

Euro-area and U.K. bond markets are closed on Friday. Debt sales next week from Germany and Italy total 11 billion euros. There are no redemptions until April 9, when Germany will pay 21 billion euros, while Italy pays small coupons of about 500 million euros.

  • The U.K. holds no bond sales but the BOE will buy back 4.4 billion pounds of debt across three operations
  • Inflation numbers dominate the coming week’s data releases, with German numbers on Tuesday followed by the euro area’s flash estimate on Wednesday; U.K. data is mostly second-tier and backward looking
  • ECB and BOE speakers are few and far between in a holiday-shortened week with Francois Villeroy speaking on Wednesday
  • S&P Global Ratings reviews France next week

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