Europe’s Bond Selloff Signaled Unsustainable by Inflation Gauge

Kapstream's Palghat: Don't See Bear Market in Bonds
  • Five-year, five-year forward rate falls from one-month high
  • Central banks will act ‘when push comes to shove’: Rabobank

Bond traders are showing little confidence the European Central Bank’s policies will stoke inflation, leading them to conclude that the current selloff isn’t a repeat of the rout of mid-2015.

The five-year, five-year forward inflation-swap rate, a gauge of price-growth expectations, has fallen this week from the highest in a month. Bond bulls were further bolstered by data Thursday showing euro-zone inflation held at just 0.2 percent in August, well short of the ECB’s goal of just under 2 percent.

A rally that’s handed holders of euro-region debt more than 5 percent this year has been unraveling since Sept. 8, when ECB President Mario Draghi failed to signal a further bout of quantitative easing. Yet with the economy in the doldrums, some investors are speculating that he’ll have to act sooner or later. Stimulus is good news for bonds; inflation, bad.

“Given the still very uncertain global outlook we’d argue that this sudden rise in yields and the steepening of the curve may not last,” said Elwin de Groot, senior market economist at Rabobank International in Utrecht, Netherlands. “There’s some concern that these central banks aren’t willing to go any further, but when push comes to shove, when we see that inflation is not picking up convincingly, what can they do? They’ll have to.”

Global Phenomenon

This speculation goes beyond Europe. Futures prices suggest the Federal Reserve will refrain from an interest-rate increase on Sept. 20-21, while the Bank of Japan is reviewing its debt-buying measures before its meeting over the same two days. The Bank of England kept borrowing costs on hold today, but indicated there’s still a chance of another cut this year as it assesses the fallout of the Brexit referendum.

German 10-year bund yields rose one basis point, or 0.01 percentage point, to 0.03 percent as of 4:25 p.m. London time, after climbing from below zero on the day the ECB met. The zero percent security due in August 2026 fell 0.09, or 90 cents per 1,000-euro ($1,124) face amount, to 99.695.

The inflation indicator, which Draghi has cited when advocating monetary stimulus, was at 1.31 percent, down from 1.32 percent on Sept. 12.

Bonds in the euro-region periphery led today’s declines, with Portugal’s 10-year yield surging 15 basis points to 3.41 percent -- touching the highest since June -- and Italy’s up four basis points at 1.33 percent.

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