Deutsche Bank Research said European assets have been reacting to a renewed energy shock, prompting a hawkish repricing of expectations for the ECB. Market pricing for rate rises by December increased by 12.7bps on the day to 39.5bps, and with the ECB already having delivered a June hike, the curve points to a growing chance of three moves by year-end.
Sovereign bonds sold off as yields pushed higher across the region. The 10-year Bund yield rose 9.9bps to 3.09%, its biggest daily jump since May, while France’s 10-year OAT yield climbed 13.5bps to 3.93%, the highest closing level since 2009.
Hawkish ECB Repricing And Widespread Bond Selloff
We are seeing a significant hawkish repricing for the European Central Bank, driven by a renewed energy shock. Dutch TTF natural gas futures have surged over 20% in the last two weeks to over €55 per megawatt-hour, fueling new inflation worries. The market is now pricing in a strong possibility of three total ECB rate hikes by December.
The sovereign bond selloff is accelerating, and we see further weakness ahead. With the German 10-year Bund yield pushing past 3.15%, its highest level this year, we believe short positions in Bund futures offer a direct way to trade this momentum. French OAT yields hitting their highest since 2009 signals that the pain in government debt is widespread.
Currency Outlook And Risks To European Equities
This environment should provide a tailwind for the Euro, which we’ve seen climb toward 1.09 against the U.S. dollar. We suggest traders could use call options on the EUR/USD pair to position for further upside as rate differentials shift in the Euro’s favor. However, we are mindful of the 2022-2023 hiking cycle, where persistent recession fears eventually capped the currency’s strength.
Higher rates are a direct threat to equity valuations, and we anticipate increased market turbulence. The latest Eurostat flash estimate showing headline inflation ticking up to 2.8% will only add to the pressure on stocks. We believe buying put options on the Euro Stoxx 50 index is a prudent strategy to hedge against a potential market downturn in the coming weeks.
