EURi: ECB lights a path to the peak; Weighting for Germany

Real yields tumble after ECB lights a path to the peak

‘Listen to what I say, not what I do’ seemed to be the message that inflation traders and the wider market took from the last 24 hours of softer-than-expected central bank commentary. Today’s ECB-driven and peripheral-led bond rally saw the BTP skip towards the close almost four points higher and, in yet another blow for ‘beta’, linkers almost kept up with the moves.

Broadly speaking, inflationistas advanced two views of the rally. Some cited short-covering as key, with the Bund future seeing volume of over 1.2m and the BTP approaching 300K. “Central banks were hawkish (with higher rates) but the market was already short so it was more position-driven than macroeconomic, I think” reckoned one.

Others though pointed to the softening in the ECB’s previously hawkish tone (which arrived on the heels of a similar verbal shift by the BOE), with the central bank acknowledging that inflationary pressures are starting to ease.

That rhetorical shift sharply increased confidence that the outlook for rates from here will be +50bps in March, as signalled by the ECB, then +25bps in May. €STR forwards trimmed 12bps from rates for the June meeting, putting the likely peak in May or June and leaving the coast clear for Q3 and Q4. The forward curve also cut 20bps from ECB rates in December.

The ECB comments on the APP were seen as expected by traders, with the central bank planning to shrink its holdings by around €15bn a month. While viewed as a negative factor for breakevens (having been positive for inflation when the ECB was buying bonds), the link to redemptions and the limited size of the program per month, meant that the effects were expected to be bond-specific and skewed to later in the year.     

Meanwhile breakevens were described as “weak” today but were only -2bps despite a 15-20bps rally in core real yields, increasing to 25-35bps for BTPei.

“Long end OATei were pretty weak,” added one trader, pointing to their richness in iota as a reason. And cash generally was deemed soft versus swaps. “Swaps rebounded at the end of the day but cash just stayed stuck."

EUR 1y fell by 7.5bps to 2.3225% against a backdrop of weaker oil prices and a 4% drop in Dutch gas futures but some traders spotted profit-taking from front end longs as well.

Unusually, the Jan23 fixing fell by around 6bps and traded at 8.81%, according to the SDR. Dealers suggested that although some bank economists saw the risk of an upward revision to the flash HICP print once the German data is released (see below), others suggested that Eurostat’s flash estimate was likely to capture the impact of the energy price cap.    

EUR 5y5y rose by 1.25bps to 2.31% as the curve steepened. For swap trades please see the Total Derivatives SDR , which now also includes information on broker/platform for the trade in question.

Asset swap interest in the BTPei was expected to survive the richening in real yield levels today, with the rally and the ECB interest rate outlook seen as increasing confidence in long asset swap positions.

In cash, Spain sold a modest €505m in SPGBei-30 with the auction judged dealer-friendly given the bond’s RV and its post-auction outperformance against the SPGBei-33.

Elsewhere, German announced plans to sell €500m in the Bundei-26 and €200m in the Bundei-46 next week with dealers today sounding happy about the DFA’s auction choices.

Further ahead, some wondered whether the drop in real yields would encourage the AFT to launch a new French linker this month. But “if they do the 30y OAT next month, I don’t think they’ll do the new OATi soon”, reckoned one dealer, instead “maybe a month later”.    

Weighting for Germany: Barclays

In research, analysts at Barclays update their inflation forecasts following the flash HICP data and assess the impact of the index reweighting.

Currently, the bank sees HICPx printing at 119.78 in January (8.60%yoy) and 120.49 (8.21%yoy) in February, slowing to 5.01% in June and 3.13% in December as the core rate drops from 5.25% this month to dip under 3% to 2.86%yoy at the very end of 2023.

Still, even the very near term outlook for inflation is clouded by data issues, as Barclays explains: 

“Based on the flash Euro Area HICP inflation reading (8.5% y/y), we infer Germany HICP inflation was projected at around 8.9% y/y, significantly below our and Bloomberg consensus estimates of 10.2% y/y. Given that the pick up in German inflation was expected to be driven by technical factors which may not have been fully accounted for in the flash Euro Area HICP print, we see a non-negligible risk of an upside revision of Euro Area January HICP in the final release scheduled for 23 February”.

And the impact of this month’s index reweighting is non-zero, with analysts waiting for the detailed numbers to gauge the effect on seasonality:

“Based on available provisional 2023 basket weights for high-level Euro Area HICP aggregates, the effect of basket weight changes on EA headline/core inflation in January was likely rather small, -5bp/+3bp compared to the high-level aggregation performed at 2022 weights. Across components, the weight of services has been revised higher, albeit it still remained below pre-COVID. In turn, weights of non-energy goods, food and energy components were downgraded from 2022, despite all three categories printing record-high inflation this year.”

 

“Given that we were expecting a material upgrade of energy and food categories, the top-level basket weight revision fell somewhat short of our expectations. However, the redistribution of weights across low-level categories will be particularly important for our monthly and quarterly inflation projections. In particular, weights of volatile components, ie, clothing, air fares and package holidays, should materially affect summer and winter inflation seasonality.”