Brexit Threat to Euro-Area Inflation Becomes Bondholders’ Boon

Draghi Avoids Brexit, Calls for Global Policy Alignment
  • German yields negative as far out as 15 years on stimulus bets
  • Futures show almost 50% odds ECB cuts rates in September

Mario Draghi’s headache after Britain’s decision to exit the European Union is proving to be a gift for holders of the region’s riskier government bonds.

A measure of investors’ inflation expectations slumped to a record after last week’s Brexit vote, making an extension of the European Central Bank’s asset-purchase program almost a certainty for some investors. Lower consumer-price increases enhance the value of payments from fixed-income securities, and hamper ECB President Draghi’s principal goal of guiding inflation back toward 2 percent.

The investor speculation is helping to extend a rally that pushed yields on Spanish 10-year bonds to the lowest in more than a year on Wednesday. While gains by German securities have slowed, the nation’s 15-year bonds have now joined the group that yields less than zero.

With traders pricing in looser policy from Washington to Tokyo after the U.K.’s shock vote drove down inflation, dimming the outlook for global growth, investors are for now ignoring potential risks to the creditworthiness of Europe’s high-debt, high-deficit nations, according to Peter Chatwell, head of rates strategy at Mizuho International Plc in London.

Debt Sustainability?

“The ECB is going to have to extend the program in September and cut rates, and so if you think about what this means for the periphery, yes, it is supportive,” Chatwell said, referring to the central bank’s quantitative-easing program. “What the market is not pricing, is that having lower growth and weaker inflation also means the debt-sustainability question comes back.”

Spain’s 10-year bond yield fell six basis points, or 0.06 percentage point, to 1.26 percent as of 4:50 p.m. London time, after dropping to 1.23 percent, the lowest since April 2015. The 1.95 percent security due in April 2026 rose 0.55, or 5.50 euros per 1,000-euro ($1,110) face amount, to 106.38.

Italy’s 10-year bond yield dropped three basis points to 1.37 percent, extending the 16 basis-point slide over the previous two days.

The five-year, five-year forward inflation-swap rate, a rolling gauge of inflation expectations that Draghi has cited when advocating monetary stimulus, was at 1.32 percent. It reached 1.257 percent on June 27, the lowest based on closing prices since Bloomberg started tracking the data in 2004, and far from the ECB’s goal of just under 2 percent.

There’s a 48 percent chance that the ECB will cut rates in September, and 72 percent odds of that move by the end of the year, according to futures data compiled by Bloomberg.

Euro-area government bonds have returned 1.2 percent between June 24 -- the day when the Brexit result became known -- and Tuesday, according to Bloomberg World Bond Indexes, pushing their gain in 2016 to 5.2 percent.

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