Is Europe waking up from long sleep? - May 03, 2015

Is Europe waking up from long sleep?

It seems that markets and investors start to believe in growing European economy, even stronger for longer-term. Lending by euro-area banks to companies and households rose for the first time in three years in a sign that record monetary stimulus is finally reaching the economy, according to the Bloomberg.

Also the money markets are starting to reflect this kind of accommodation because the European government yields have been rising for days. On Thursday (29 April) there was an obvious rush to exit from German Bunds. Yields were moving up 12 basis points to 0,285% that is a very serious phenomenon. On 17 April the German 10-Year Bond yield were only 0,05% hitting fresh record lows since the ECB began purchases of public-sector bonds in March. But the Italian bond yields were also rocketing from 1,15% to 1,51% reaching 2-month high as well as the Spanish and French.

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The German 10-Year Bond yield from 2014
There was an interesting note from the 71-year-old king of bonds, Bill Gross of Janus Capital Group on 21 Apr that German 10-year Bunds were "the short of a lifetime, better than the pound in 1993. Only question is timing / ECB QE.” (Source) The timing was quite good and probably this trading idea will work very well but don’t be surprised if this upwave of yields is not the real movement and there will be another round of drop in yields in order to test the lows recorded in middle of April.

Other interesting fact is that the euro has been steadily rising against the dollar since middle of April from 1,05 to 1,13 level. Technically we know that euro shorts are a crowded trade, the CFTC futures positioning data shows net euro shorts near a record. So rising euro easily squeeze out the shorts generating higher prices and possibly some long-term trades are also being unwound. Fundamentally, there will be a quick adjustment regarding the asset prices mainly in bond yields as fears about deflation will diminish as oil price stabilise and also the growing European economy emerges.

Rising bond yields (selling bonds) are reflecting that expectation comes back to the reality. As those traders holding European bonds exited the trade, they also unwound the hedges, which meant buying euros and selling dollars. We also have seen a nice sell-off in the German DAX index correcting from all time high (reflecting the first round effect of quickly rising yields but the European recovery is a good news for stocks in general). The index has risen almost 20% since January.

These movements, namely rising bond yields and euro and falling stock market had all the hallmarks of institutional, real money traders bailing out on what had been a very successful trade in the past months. It seems that expectations are changing in the background and investors start to see growing European economy and inflation.

By Innovative Securities

(Image: Wikimedia)