For Euro-Area Traders, Inflation Is in the Eye of the Bondholder

  • Five-year gauge of price growth climbs to two-month high
  • Inflation rate to recover ‘quite significantly’: DZ Bank

While the inflation rate may be dropping in the euro area, investors’ expectations for future price growth in Europe are picking up.

A measure of those expectations for five years from now touched its highest level since March on Wednesday, on a closing basis. The outlook helped push Germany’s government securities lower with their French peers, even as a report showed euro-area consumer prices fell an annual 0.2 percent in April. Bonds extended their declines with Treasuries before the Federal Reserve releases of minutes of its last meeting.

Oil futures traded in New York held near a seven-month high. A recovery in petroleum prices feeds into predictions of faster inflation and tighter future monetary policy which, in turn, weighs on government bonds because they’re fixed-income securities. Even as euro-area inflation lags behind the ECB’s goal of close to 2 percent, price-outlook gauges indicate investor concern is waning that deflation is around the corner.

“We expect inflation to recover quite significantly from these low levels,” said Daniel Lenz, lead market strategist at DZ Bank AG in Frankfurt. While there are still doubts on inflation climbing back to 2 percent levels, it being at or below zero for much longer is unlikely, and “this could give bund yields a lift,” he said.

German 10-year bund yields rose three basis points, or 0.03 percentage point to 0.17 percent as of 4:42 p.m. in London. The 0.5 percent security due in February 2026 fell 0.34, or 3.40 euros per 1,000-euro ($1,128) face amount, to 103.22. The yield on similar-maturity French bonds climbed four basis points to 0.51 percent.

1.5% Inflation?

The five-year, five-year forward inflation-swap rate for Europe was at 1.47 percent on Wednesday and earlier touched 1.50 percent, the highest on a closing basis since March. The gauge had dropped to a record-low close of 1.361 percent on Feb. 29, in data going back to 2004.

In the past month, as the inflation-outlook measure advanced, euro-area government bonds overall have lost 0.1 percent, according to the Bloomberg World Bond Indexes.

The five-year inflation swap has decoupled from the swift advance in oil prices, DZ Bank’s Lenz said, and thus there is “some room” for this measure to advance further.

Wake-Up

Financial markets are reawakening to the risk of the Fed expediting interest-rate increases. Bonds fell amid speculation the minutes Wednesday will signal policy makers intend to stick to their plan to raise interest rates twice this year.

“There’s been a repricing of U.S. rates expectations, and that put pressure on Treasuries and weighed” on other markets, said Nick Stamenkovic, a bond strategist at broker RIA Capital Markets Ltd. in Edinburgh. “It’s largely driven by the U.S.”

Investors also had to make room for new supply from Germany. The nation sold 10-year bunds Wednesday, with an average yield of 0.14 percent. That was the lowest since April 2015, when the yield touched a record-low of 0.13 percent.

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