European Bonds Post Worst January on Record Amid Political Angst

  • Accelerating inflation prompts bets for ECB ending stimulus
  • Old Mutual shifts short positions to peripherals from Germany

Euro-region bonds handed investors the worst start to a year on record as heightened political risk across the currency bloc added to speculation the European Central Bank may bring its asset-purchase program to an abrupt halt in 2018.

With general elections scheduled in France, Germany and the Netherlands this year amid an increase in support for anti-euro rhetoric, yields on French and Italian bonds climbed this week to their highest level relative to benchmark German debt since 2014. In the face of stronger growth and rising inflation, some investors aren’t listening to Mario Draghi when he says the ECB hasn’t considered tapering its bond-buying plan.

Rising populism in the region’s biggest economies and speculation that the ECB’s stimulus plan may be nearing its endgame have clouded the horizon for bond investors, who have grown used to the central bank insulating euro-area securities from political tension. That’s seen yield spreads expand to levels unseen since quantitative easing began in 2015, and left analysts forecasting more pain if electoral risks materialize, particularly in light of the extreme market reactions seen in the wake of Donald Trump’s victory in the U.S.

The market’s move suggests Draghi’s insistence last year that policy makers weren’t considering scaling down stimulus and caution in January that underlying inflation showed “no convincing signs” of picking up is falling on deaf ears.

“The market is obviously seeing through this,” said Mark Nash, the head of global bonds at Old Mutual Global Investors, which oversees about $37 billion. It’s “seeing that quantitative easing has to come to an end soon.”

Peripheral bonds may come under further pressure should “markets continue to worry about the integrity of the euro zone,” London-based Nash said. Italy’s “banking system is obviously still impaired. Also, likely elections and political risks” may hurt the nation’s bonds. Nash said he shifted short positions to Italy and Spain from Germany.

The End of the ECB’s QE Could Be a Lot Closer Than You Think

Data released Tuesday showed annual euro-area inflation surged to 1.8 percent in January. That’s the highest in almost four years and approaching the ECB’s goal of just under 2 percent. Faster inflation is increasing calls, especially in price-wary Germany, for policy makers to end stimulus that’s seen the ECB buy 1.32 trillion euros ($1.42 billion) in assets since March 2015.

The market’s “been raising the potential for a hard stop to quantitative easing at the end of this year if we do continue to get these rises in inflation and growth,” Nash said.

Draghi said in December that asset purchases will slow to 60 billion euros a month from April, from 80 billion euros currently, and remain at that pace until at least the end of this year. Still, this does not, he said, imply a ‘taper’ toward zero.

The yield on Germany’s 10-year bunds touched a one-year high of 0.50 percent on Jan. 26, while that on similar-maturity French bonds rose to a 16-month high. Euro-area sovereign debt handed investors a 2.1 percent loss in January, the worst start to a year in data going back to 1998, according to the Bloomberg Barclays Euro Treasury Index. 

Old Mutual’s Nash and Societe Generale SA both see 10-year bund yields rising to 1 percent this year. That’s higher than the weighted-average forecast of 0.67 percent by year-end of 34 economists in a Bloomberg survey.

With German wage and inflation picking up “the potential is still for yields to go higher into the year-end,” said Ciaran O’Hagan, the head of European rates strategy at Societe Generale. “The ECB is probably going to taper sooner rather than later and the prospects of that are negative for bonds.”

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