Europe Bonds Extend Losses as ECB Spotlights End to Crisis Aid
(Bloomberg) -- Europe bonds extended declines as hawkish European Central Bank comments reminded traders that the ultra-accommodative policy seen at the height of the coronavirus crisis may be on borrowed time.
Italian 10-year yields led borrowing costs higher, hitting a five-week high after Governing Council Member Robert Holzmann said the ECB should start debating how it will phase out its pandemic-era stimulus at its next meeting. His colleague Klaas Knot said the region’s inflation outlook may have improved markedly enough to justify an immediate slowdown in stimulus.
Their comments came after Bank of France Governor Francois Villeroy de Galhau said on Monday that officials should take into account more favorable financing conditions in the region, hinting a slowdown in bond buying may be in the cards.
While in recent months, Holzmann had raised the prospect of an end to the ECB’s emergency bond purchases, the nuance of his latest comments was enough to catch markets’ attention. He said he sees no reason to make the ECB’s regular quantitative-easing program akin to PEPP, which is due to expire in March 2022.
“The most interesting part is that he says the Asset Purchase Programme doesn’t need the same kind of flexibility of the Pandemic Emergency Purchase Programme,” Piet Christiansen, chief strategist at Danske Bank A/S. “This is something that markets seemed to take for granted.”
While major central banks such as the Federal Reserve and the Bank of England have signaled their intention to gradually unwind crisis-era aid, the ECB has stuck to its ultra-loose policy to cushion Europe’s fragile rebound. That has weighed on the European currency, though Fed Chair Jerome Powell’s Jackson Hole address last week -- which traders interpreted as more dovish than expected -- helped it bounce off multi-month lows.
For now, euro volatility suggests options traders aren’t expecting any surprises at the Sept. 9 ECB meeting. The two-week gauge trades at 5.25%, below its year-to-date average. While options bets on the tenors are less bullish on the dollar, the moves remain contained.
This may be due to policy makers’ comments on risks to the outlook. Holzmann said earlier this week that inflation next year will sink compared with 2020, while Villeroy noted there is no urgency to decide on PEPP next week.
In rates, volatility selling strategies have performed well since the second quarter in part due to the ECB’s strengthened forward guidance, according to Tanvir Sandhu, Bloomberg Intelligence’s Chief Global Derivatives Strategist.
Still, 10-year bund yields have struggled to extend declines past minus 0.50% and may need rate cut pricing for yields to sustain below that level. That creates opportunities to fade rallies, he said in a report.
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