David Roberts

A change of tack for Super Mario

David Roberts

Five years after his “whatever it takes” speech, European Central Bank (ECB) President Mario Draghi finally seems to think his job here may be done.

During a speech to the European Parliament earlier this week, he referenced a “relatively vigorous” pick up in core inflation, with attendant comments on a tight labour market and wage price pressure. For the first time since June, German 10-year bond yields moved above 0.5 per cent.

Also adding to the fun, Governor of Austria’s central bank and ECB council member Ewald Nowotny suggested Draghi was wrong to state recently that interest rates would remain on hold until late 2019.

Hawkish central bankers and a bond market that is still incredibly expensive suggest investors in German Bunds could see significant losses for the remainder of this year and next – in addition to the losses they have already experienced year to date.

Indeed, the next big leg downward in Bund prices could come on Thursday. Italian politicians are due to update their budget targets – should they show restraint, with a deficit target of 2 per cent of GDP or less for example, then the need to own German debt as a “safe haven” will be further eroded.

Italian debt is still too volatile, too opaque for many bond investors to consider. We currently have a negative exposure to German debt, a far safer way to play “Euro convergence”. And of course, we much prefer the US where we received more than six times the income we do in Germany.

A recipe for capital loss? Take five ingredients:

  • Euro employment heading to record levels: stoking wage inflation?

  • ECB Bond buying program to end in December: who will buy then?

  • Material rate hikes to come: more than currently expected?

  • Italian politics much improved: reducing safe haven need?

  • Bund yields 1.5 per cent below German inflation: “real return” losses anyone?

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Wednesday, September 26, 2018, 11:20 AM