The Europe Capitulation Trade Is in Full Swing on Vaccine Bets

A sudden rebound in the euro and a selloff in bond havens are forcing investment strategists to play catch-up on rising expectations for European growth.

As the currency climbs toward $1.20, some in the investment community worry their projections for the months ahead look too gloomy. Goldman Sachs Group Inc. this week revised up its three-month forecast to $1.25 from $1.21. Meanwhile, BNP Paribas, Pictet and Manulife Investment are predicting German bond yields will turn positive by December for the first time in two years.

The Europe Capitulation Trade Is in Full Swing on Vaccine Bets

Just weeks ago, the euro was mired in its worst start to the year since 2015, dogged by stubbornly high Covid infections and the European Union’s fumbling of its vaccination program. The yield on German 10-year bonds, the region’s go-to haven, was at its deepest discount to its U.S. counterpart in more than a year.

Now, the EU’s rollout of immunizations is getting into gear with a renewed drive to cover the bulk of its population within a few months. Meanwhile, data are turning positive and last week saw a robust increase in factory orders for Germany, the region’s biggest economy.

Shifting Dynamics

The recovery in the single currency is set to continue, according to Charles Diebel a money manager at Mediolanum who says it could reach $1.25 by year-end.

“The euro has been an underperformer against the dollar and a sterling laggard in terms of vaccine rollout,” he said “But those dynamics are shifting now, and with good news already in place in the U.S. and the U.K., Europe is catching up.”

That optimism is also rippling into the bond market, squeezing German 10-year debt. Bund yields have climbed 30 basis points from this year’s low to minus 0.29% and Goldman Sachs sees them rising to 0%. BNP Paribas predicts 0.2%, the highest level since early 2019.

“The pace of vaccinations in Europe should ramp up soon,” said Chris Chapman, a portfolio manager at Manulife Investment, who also expects the the yield to break into positive territory by year-end. “The re-opening of the economy and the catch-up of the services sector will drive growth.”

The Europe Capitulation Trade Is in Full Swing on Vaccine Bets

But with Covid infections still rising in much of Europe and just just 11% of the EU population vaccinated, that optimism is far from universal.

Bank of America Corp. strategist Sphia Salim sees bund yields ending the year at -0.25%, though she concedes the bank’s economists are more bearish than the consensus on growth and inflation. HSBC’s Chris Attfield predicts -0.5%, saying most of the good news is already priced in.

Ominous Sign

Meanwhile, in an ominous sign for those placing bullish bets on the recovery, so-called speculative investors -- mainly hedge funds -- have cut long euro positions to the lowest in a year, according to Commitments of Traders data. The median year-end outlook for the euro among analysts contributing forecasts to Bloomberg remains at $1.22.

Many traders are wagering on a stronger euro, however. Options betting on gains against the dollar trade at a premium over those looking for declines across tenors out to six months. Against sterling, that premium stretches to one year. Meanwhile, analysts are revising their end-2021 forecasts for German 10-year yields by the most in more than a year.

Goldman Sachs says the biggest four euro economies will probably have given Covid shots to around 37% of their populations by the end of May, rising to 54% a month later. The bank is suggesting investors go short on European bond duration.

“Our economists remain optimistic on the European recovery as data have been resilient and vaccination is likely to accelerate from here,” strategists including Christian Mueller-Glissmann wrote in a note.

Next Week

  • The European Central Bank’s April meeting dominates the calendar, with policymakers likely to sound cautiously optimistic on Thursday without giving away details about the pace of weekly stimulus beyond 2Q
    • Flash PMIs on Friday will give insights into how economies are faring
  • Eurozone sovereign supply will remain above the year-to-date average at about 27 billion euros with auctions in five countries, as well as the sale of a new BTP Futura, according to Commerzbank
  • The U.K., meanwhile, will sell more than 5 billion pounds worth of gilts maturing in 2024 and 2035, with employment and inflation data Tuesday and Wednesday in focus
    • U.K. unemployment probably stabilized in February, while inflation is seen nudging up in March

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