Investors rushed to offload German bonds and money markets cranked up rate-hike wagers after European Central Bank Executive Board member Isabel Schnabel said she saw risks that markets will underestimate inflation.
(Bloomberg) — Investors rushed to offload German bonds and money markets cranked up rate-hike wagers after European Central Bank Executive Board member Isabel Schnabel said she saw risks that markets will underestimate inflation.
For the first time, traders fully priced in a 3.75% terminal deposit rate by September, according to swaps tied to ECB meeting dates. That’s up from a low of 3.4% expected following this month’s ECB policy outcome.
At the same time, odds of a rate cut this year were reduced to just one basis point, the least since the middle of December. Germany’s 10-year yield jumped as much as 9 basis points on Friday, reaching 2.57% and nearing the highest level since 2011.
The sharp moves followed Schnabel’s interview with Bloomberg, in which she said “there is a risk that inflation proves to be more persistent than is currently priced by financial markets.” ECB officials earlier this month raised borrowing costs by half a point to 2.5%.
ECB’s Schnabel Sees Risk Markets Underestimate Inflation
“A terminal rate of 3.75% seems very reasonable,” said Marc Ostwald, chief economist and global strategist at ADM Investor Services, adding that the market had been underpricing the risk of higher rates. “As we get closer to the March ECB meeting, what she is saying is that it is probably going to revise its inflation forecast higher.”
Signs of slowing prices had provided a boost for bonds, but the market came under renewed pressure last week following a number of hawkish statements by policymakers, while strong US economic data also signaled the possibility of higher-than-expected rates there.
Italian bonds joined the selloff on Friday, pushing their premium over German counterparts up as much as 7 basis points to 192, the highest since Feb. 2. For UniCredit SpA, the current level of 10-year bund yields is a buying opportunity.
“If headline inflation continues to ease and core inflation turns in the coming months, as we expect, investor expectations on the peak deposit rate, as reflected by forwards, are likely to decline,” Luca Cazzulani, head of strategy research wrote in a client note.
UK bond yields rose 4 basis points to 3.54% after retail sales unexpectedly grew in January. US 10-year yields rose as much as 6 basis points to 3.93%, the highest since Nov. 10.
(Updates throughout.)
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