Global Rates: Dissecting the sell-off in European rates, next week’s BoE meeting

Francis Diamond (0:03)

Hi, and welcome to At Any Rate, JP. Morgan's global research podcast, where we take a look at some of the drivers behind the biggest trends and themes across fixed income currencies and commodity markets. I'm Francis Diamond, Head of European Rate Strategy at JPMorgan. Today, I enjoyed my colleagues, Aditya Chordia and Khagendra Gupta, to discuss the recent sell-off in European rates this week, Buksal CCD switch risk, and next week's BOE rate meeting. This week, these be delivered a 25-base point rate hike, with front-end now pricing another roughly 80-base points of hikes over the next 12 months.

Similarly, the Sonja front-end curve prices around about 100 basis points of hikes over the same period from the BOE. This week, we will see 10-year buns reach multi-year highs at 3.5 percent, and 10-year gilts close to 5.3 percent. Aditya, this sell-off in European rates we've seen this week has been pretty sizable. If you look at the front end, 1.1 ester is at 3.25.

Is all this about just the rise in oil and gas prices, or did the speed delivery this week also drive some of the move in front-end rates?

Aditya Chordia (1:05)

Thanks, Francis. The front end, if we start from there, the money markets, like ester was already selling off for going into the ECB over the last couple of weeks.

Primary driver has been, in our view, the Middle East conflict with it because of the re-escalation, the energy prices have significantly increased. And I think, on top of that, there has been a lot of anecdotal evidence that there has been an ongoing wave of pushing washouts where investors who might have been receiving at the very front-end have been stopping out because of the sharpness of the moves. So I think that also added to the large moves on the large sell-off you have seen at the very front-end. And then the ECB, indeed, the projections on the inflation side were hawkish, versus the market expectations. So it did add to the sell-off momentum. It has calmed down a bit today, but overall, I think it was mainly the Middle East led energy price moves, a combination of position washout and then ECB adding a bit to the hawkishness. Thinking about the valuations and everything, so our economists have another 25 basis point of hike from ECB in December, but they are clearly flagging that given the recent energy price moves and the ECB projections, the risk is that could be another 25 basis point in March next year, so a cumulative of 50 But clearly, as I mentioned, market is pricing a cumulative of around 75 to 80 basis points, so a terminal of 325 It clearly looks much higher or stretch compared to our positions, but we still believe that given the limited visibility over energy prices, it's really hard to be actively pushing back on the current market pricing.

Francis Diamond (2:43)

So further out, there's been a lot of focus on the rise in 10-year and long yields globally. So do you think global dynamics are explaining why 10-year bonds are 3.5 percent, or are there idiosyncratic European drivers that can also explain this?

Aditya Chordia (2:58)

So I think the intermediate part of the curve has been a combination of stories, and that's why the move there is not something which we were expecting, let's say, a couple of weeks back. So as you mentioned, the bond yields have made new highs, we had 3.50. I think the last time we saw was more like 2011 When I look at the underlying drivers, even this week, it was the same drivers which we have been driving in over the past couple of weeks. So it's partly driven by the repricing higher of ECB terminal rate on rising energy prices, the one we discussed about. But also, it has been partly driven by the limited bear flattening move in the money market curve. Because typically, you expect in a large front-end repricing, the money market curves tend to bear flatten. But this time around, what happened is on the margin over the past few weeks, the money market curve have not flattened on the margin, at times they have even steepened. And I think that's what's mostly driving the intermediate yields higher. And that's something, as I said before, we were not anticipating. And I believe that a combination of factors could be behind the lack of this bear flattening on the money market curves. First being, higher neutral rate expectations. That's a narrative which has been going around, but something which might have been, which given the recent economic resilience and also the broader AI-driven productivity gains narrative, I think it has got a bit more attention. Still elevated beta to US rates, where global rates have sold off in the intermediate part of the curve for different reasons compared to Euro, but those have pushed Euro yields higher, given beta still remained elevated. CTA activity, when we look at some of the moment of signals which we produce in our team also, we are seeing the signals pointing to max short.