May 8, 2017 / 6:50 AM / 8 months ago

South European yields spike as market bets on ECB tapering after Macron win

LONDON (Reuters) - Low-rated South European government borrowing costs rose on Monday as investors speculated that the French presidential election win for centrist Emmanuel Macron will strengthen the case for a tighter monetary policy stance in the bloc.

Macron won the election to become France’s president on Sunday, a result hailed by European leaders as a vote for unity and a blow to political forces that had sought to build on last year’s Brexit vote to tear apart the European Union.

Though Macron was the market favourite, an early rally in low-rated euro zone bond yields dissipated on Monday morning.

“Investors will now go back to the basics of watching the underlying euro zone economic and inflation data and what implications it may have for monetary policy,” said Iain Stealey, a fixed income portfolio manager for JP Morgan Asset Management, one of the biggest bond investors in the world.

“The underlying GDP data is too strong for there to be 60 billion euros (£51 billion) of (bond) purchases and though inflation numbers are below target, they are not low enough to justify a negative deposit rate,” he said, referring to the ECB’s bond-buying scheme.

Analysts said the market is also wary of other political risks, with votes coming up in Germany and Italy in the next 12 months and parliamentary elections to be held in France in June.

At the market open on Monday, there were falls in French and Italian government bond yields, and the premium investors demand to hold 10-year French government debt over German equivalents tightened to its lowest since early November at 32.7 basis points.

As the session wore on, that spread widened to 36 bps, and Italian, Spanish and Portuguese 10-year government bond yields rose 4-6 basis points.


These countries are seen as the most vulnerable to any signs of tapering, as their borrowing costs are seen as having benefited the most from the ECB’s bond-buying scheme.

“The tail risk of ‘Frexit’ is out of the way but now people seem to be either shifting their attention either to ECB tapering or to other elections coming up,” said ING strategist Martin van Vliet.

He said there may also be some “buy the rumour, sell the fact” trades taking place, with the French-German 10-year government bond yield spread having tightened substantially in the days leading up to the vote. Italian, Spanish and Portuguese bond yields have also fallen this month so far.

German 10-year government bond yields were lower 3 basis points to 0.389 percent on Monday, having risen over 25 basis points in the last three weeks.

Earlier this month, data showed euro zone consumer inflation rose to 1.9 percent in April, beating forecasts of 1.8 percent, and close to the ECB’s target of just below 2 percent.

Preliminary estimates showed last week the euro zone economy started the year with robust growth that outstripped that of the United States and set the stage for a strong 2017.

After the first round of the French election, sources on and close to the ECB Governing Council told Reuters many rate-setters see scope for sending a small signal in June towards reducing monetary stimulus.

With German Chancellor Angela Merkel gaining momentum ahead of the German federal election in September, political risk appears to have diminished for the rest of the year, said Stealey, with Italian elections likely to be called next year.

Merkel’s conservatives won a decisive victory over their Social Democrat (SPD) rivals in a vote in Germany’s northern state of Schleswig-Holstein on Sunday, boosting her prospects of winning in September.

Reporting by Abhinav Ramnarayan, editing by Nigel Stephenson and Janet Lawrence

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