European bonds finally caught a break after violent swings tied to fast hedge fund repositioning. Earlier in the week, France's 10 year yield fell by up to 16 basis points one day, then jumped 18 the next. That turbulence came alongside an unusual split between German and French moves, which has since faded as oil cooled and there were no fresh headlines out of France.
Crude eased after U.S. President Donald Trump said he would refrain from ordering further strikes on Iran ahead of November's midterm elections, helping Brent drift back toward the $100 mark. "A sense of normality is returning, with correlations establishing their usual patterns and oil lifting all boats," said Christoph Rieger, head of Commerzbank AG's rates and credit research team. He added that German and French bond moves have realigned after last week's divergence.
Bond markets steady when the thing that scared them stops getting worse. Market Briefs reads fixed income free every weekday.
Lower oil takes some pressure off government budgets, and you could see that in prices. French debt was set for its first weekly gain in six weeks, and Italy for the first in nine. The premium investors require to own French paper over Bunds narrowed by three basis points, landing at 1.37 percentage points. Even so, caution still rules: investors are asking for the highest pick up to hold French debt over Italian since the euro launched.
Rate expectations eased too. Interest rate swaps now signal 72 basis points of European Central Bank tightening to be completed by the close of next year, versus 75 basis points priced on Thursday. ECB President Christine Lagarde told euro area finance ministers that officials are monitoring markets and have the tools to address unwarranted, disorderly moves.
Positioning remains fragile. Jefferies' Mohit Kumar, Europe chief economist and strategist, said hedge funds will likely sell into strength to expand shorts, while long only buyers want more stability before stepping back in. "We remain short France," he said, adding that he does not see a sovereign crisis or any need for restructuring in Europe. His bigger worry is a "buyer strike," and he thinks French yields would need to widen to 200 basis points over Germany for the ECB to consider action beyond words.
France will test demand shortly. The French Debt Agency announced plans to offer as much as €12 billion (about $13.4 billion) in medium term bonds on Thursday next week. "Bond markets are clearly focused on France today," said Kevin Thozet, a member of Carmignac's investment committee. "Tomorrow it could be Japan, the UK or US - because all of them are sharing the same symptoms."
Oil and yields have been moving together more than usual. Join Market Briefs free and follow the link.
