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Rates Sell Off Continues

6 July 2017 by Mark Holman

Since Draghi’s comments in Portugal last week, the move higher in government bonds has faced little resistance. Markets are now looking for hints of hawkishness in every statement, and are ignoring the attempts by other ECB governing council members to sooth the situation.

At the time of writing today 10 year Bund yields are 56bps, from 38bps a week ago, and 24bps at the time of Draghi’s comments. In price terms this represents a significant move of over 3%.

The catalyst for today’s move can be found in the minutes of the governing council’s last meeting, where the topic of revisiting the easing bias on the asset purchase programme was discussed. Whilst the programme was left unchanged, it was noted that should further confidence in the inflation outlook materialise then this easing bias would be reviewed.

This further fuels our view that this will happen in September, when there will be a second taper and a further extension to the programme.

What also caught our eye in the minutes was the policy wording which was debated – “it was cautioned that even small and incremental changes in the communication could be perceived as signalling a more fundamental change in policy direction”. This is exactly what has happened with Draghi’s “with reflationary dynamics slowly taking hold” remarks. Either Draghi has gone off script here and this is not how the ECB is seeing things or, more likely, these words were chosen very carefully and debated by the council members. If this is the case, as we suspect, it is indeed a signal of a more fundamental change in policy direction and Draghi’s ‘Taper Tantrum’ moment has arrived.

Having said that, the market has been waiting for and expecting this for some time, so the contagion seen at the time of Bernanke’s moment is likely to be considerably less. To the extent that credit assets show signs of weakness this could present a buying opportunity, as macro indicators in Europe are as strong as they have been for a considerable time, but as far as core European government bonds are concerned, our view remains that we have a clear red light for risk here.

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