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Europe’s Riskiest Bond Markets Just Got a Boost From the ECB

·3 min read

(Bloomberg) -- European Central Bank President Christine Lagarde gave investors the green light to load up on some of the highest-yielding government bonds in the region over the coming months.

By signaling that there would be no let-up in the ECB’s pandemic debt-buying program on Thursday, she helped put aside fears that the central bank is preparing to withdraw unprecedented monetary support -- at least until September.

Italian and Greek securities extended a rally Friday as the region’s riskiest debt led a charge higher, the trade of choice for investors looking to coast on the extraordinary stimulus for a while longer.

These so-called carry trades are a staple for money managers looking to buy and hold the securities to pocket the extra return, banking on the fact that policy makers will keep borrowing costs in check. And they’re particularity popular when there’s less risk for volatility, which only underscores the room for a rally now that the ECB has made its backstop so explicit.

“The ECB has done whatever they can to influence bond markets for a calm summer,” said Piet Christiansen, chief strategist at Danske Bank A/S.

At more than 100 basis points, the extra yield on Italian and Greek 10-year debt over equivalent German bunds is almost triple the average across other euro area peers. German bondholders would have made a loss of nearly 1% over the past year, while those holding Italian or Greek debt would have netted returns of over 6%, according to Bloomberg Barclays indexes.

“The ECB’s finger is nowhere near the trigger,” said Vuk Magdelinic, chief executive officer of fixed income analytics firm Overbond. “In fact, the safety catch is still firmly on and there’s still no sign of it changing course.”

The ECB’s next policy meeting is on July 22, but the Sept. 9 session is the most likely one for any shift. The Governing Council will have another round of updated economic projections to consider, the European Union should be close to its vaccination target, and the disbursements under the bloc’s recovery fund should have started.

Heated Debate

That could make for a more heated debate over the pace of emergency bond buying and potentially encourage more-hawkish policy makers to try to start talks on how to phase out the program. The current end-date is set at March 2022.

Until then, though, the region’s bond markets can rely the ECB’s purchases. That’s a windfall for countries like Italy, where the debt load has spiraled toward 160% of economic output amid the coronavirus pandemic, yet bond yields have still plummeted to record lows .

“The ECB was wanting to avoid the impression that securities purchases could be scaled back, i.e. that the monetary policy stance could become less expansionary,” said Joerg Angele, senior economist of Bantleon Bank AG.

Italian bonds extended gains for a fourth day on Friday as the 10-year yield fell as much as five basis points to 0.75%. Greek bonds also advanced, with the 30-year yield sliding to an all-time low. The euro was broadly steady, with currency markets largely reacting to a faster-than-expected pickup in U.S. consumer prices.

While inflationary pressures the other side of the Atlantic could spur the Federal Reserve into tapering its own asset-purchase program, Lagarde warned of any undue tightening of financial conditions in Europe. She also said that inflationary pressures in the euro area were largely transitory.

Traders in money markets aren’t pricing in any rate hike from the current record-low of minus 0.5% until 2023 at the earliest, with only around one basis point of decreases priced in over the next year.

“It does set us up for a more hawkish turn, come September,” said Jacqui Douglas, chief European macro strategist for TD Securities in London. “The doves have won the summer.”

(Updates prices throughout.)

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