Home » ECB, BTP and interest rates: Lagarde presses on the hawks. But someone fears a perfect storm for Italian bonds

ECB, BTP and interest rates: Lagarde presses on the hawks. But someone fears a perfect storm for Italian bonds

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ECB, BTP and interest rates: Lagarde presses on the hawks.  But someone fears a perfect storm for Italian bonds

A rate hike sufficient to stifle inflation but not such as to provoke a sovereign debt crisis 2.0 in the midst of a war and the resulting energy crisis, and not such as to trigger further speculation against Italian BTPs, already vulnerable in view of the political elections next September 25th. The work of the ECB of Christine Lagarde is becoming increasingly tiring, while the world of hedge funds, as reported a few days ago by the Financial Timesyou are not having great problems placing the largest short bet since 2008 against BTPs and the Italian paper.

I hedge funds certainly do not forgive Italy the sin of public debt, which remains too high.

Start the countdown to the verdict of the ECB: the Eurotower Governing Council will meet tomorrow Thursday 8 September in Frankfurt to announce a rate hike in the euro area which, according to expectations a few days ago, should be 75 basis points.

On the other hand, compared to an inflation rate which in the Eurozone was equal to 9.1% in August, and with forecasts of a price run at a pace above + 10% over the next few months, a jumbo squeeze of 75 basis points is certainly a possibility. Possibility that for the markets had become almost a certainty after the speeches that some ECB exponents had made in their speeches at the Jackson Hole symposium.

ECB towards maxi rate hike? Lagarde is no longer convinced

This certainty, however, is fading, given that the same number one of the Eurotower Christine Lagarde it would be questioning the advisability of a mega rate hike.

In the last few hours, rumors have in fact circulated that Lagarde is proposing to the hawkish members of the ECB raise rates not by 75 basis points but, in a context of gas panic triggered by the stop of gas flows from Russia to Europe through the gas pipeline Nord Stream 1, and in the wake of the various alerts on the arrival of a recession, by 50 basis points.

In the daily comment to the markets signed by Giuseppe Sersale, strategist of Anthilia, rumors are confirmed:

“Rumors began to circulate of a Market News report stating that the Lagarde would lean towards a 50 bps hike on Thursday, and would be able to take the Governing Council with him ”. These rumors have also had an effect on the markets, Sersale notes:

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For in the last days many houses had married the 75 bps thesisand the consensus had shifted, these news caused a fair repricing, with Eurozone core and periphery bonds in a rally mood, and sentiment in general well supported “ (reference to yesterday’s session).

Traders had been betting not only on a more hawkish Fed for days, but also on a more aggressive ECB on rates, ready to raise them up to +75 basis points tomorrow.

Bloomberg had announced that bets on an ECB were so hawkish that traders, until a few hours before the rumors spread, were betting on a rate hike in the euro area equal to +241 basis points by July 2023double what was expected just a month ago.

But the question is: is it really appropriate to launch a strong anti-inflation bazooka at the risk of unleashing new speculations against BTPs in view of the Italian political elections? Or it would be appropriate to move more slowly in the fight against the price boom to protect everything in general the Eurozone economy from the risk of a recession even more violent than the feared one, while trying to keep hedge funds at bay against sovereign debts? Indeed, it is certainly not only the rates on BTPs that increase.

But with the ECB less hawkish risk of selling the euro and more inflation

Lagarde’s dilemma is not insignificant: also because, in choosing the most dovish route, Lagarde could trigger new sell offs on the euro which, after Gazprom’s announcement on the stop of the Nord Stream 1 gas pipeline, already broke the $ 0.99 threshold a few days ago for the first time since 2002. And a weaker euro would assist the same inflationary pressures that the Europe wants to drive out, since it would result in a further increase in the prices of those raw materials which have already blown up due to the war between Russia and Ukraine.

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At a time when the Italian charter also pays for political elections which always tend to fuel concerns about the risk of Italy, there is no lack of those who fear a perfect storm for the made in Italy government bonds.

The alert comes from the analysts of Vanda Research, who in a tweet explain in a very simple way the reason behind their outlook of a ‘Perfect Storm”.

“We see the formation of a ‘storm perfect ‘for Italian bonds. An increase in rates in addition to expectations from the ECB and the elections in Italy expected for next month are both obstacles for the BTP markets ”, they wrote a week ago.

On the other hand, there is no real BTP saving shield, despite the announcement of the European Central Bank at the end of July.

It should be remembered that, on 21 July, on the day of the resignation of Prime Minister Mario Draghi, in an Italy shaken by the government crisis, Christine Lagarde’s ECB announced the long-awaited euro area anti-fragmentation shield, known in Italy as an anti-spread shield or BTP saves.

The shield was baptized TPI (Transmission Protection Instrument).

Madame Lagarde was clear: the activation of the ICC will be at the discretion of the Governing Council of the ECB as “We will not be hostage to anyone.

And this is well known by investors who bet on BTPs, and the markets in general are well aware of it, which witnessed the10-year BTP rates soaring over 4% for the first time since June 15 and at a BTP-Bund spread which also flared up, fluctuating around 240 basis points.

In this regard, the recent report “Italy: Center right coalition ahead in the run up to the elections” drawn up by Matteo Ramenghi, Chief Investment Officer of UBS GWM in Italy and Thomas Wacker, CFA, Head CIO Credit, UBS Switzerland AG “, highlighted the danger thresholds to be observed for the BTP-Bund spread, remembering that, “In light of the ECB’s monetary policy shift, including the end of net bond purchases and the sharp rise in interest rates, risk premiums for Italian bonds have more than doubled their value from the lows tested during the pandemic” .

A few days before the 2022 general elections, yes for obvious reasons, it also rekindles attention to the doom loop and to the trend in interest spending.

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Returning to what the ECB will announce tomorrow, in a note reported by the CNBC iBerenberg Chief Economist Holger Schmieding pointed out that adopting stronger monetary tightenings at the start (of the rate normalization path) is one strategy that “Can have a stronger impact on inflation expectations than a phased approach”. And that, consequently, “A 75 basis point hike might make sense”.

That said, Schmieding also issued a warning:

“Although it is widely priced, (the upside) it could in any case exacerbate the tensions on the bond markets ”.

Sylvain Broyer, Chief Economist EMEA of S&P Global Ratings, ahead of tomorrow’s ECB meeting, clearly wrote that Christine Lagarde & Co need to do more on rates. Indeed, “much more”:

“The ECB needs to do much more on rates, as the near-term inflation outlook continues to deteriorate, while activity and the labor market remain quite resilient. At a minimum, to return to neutral territory, monetary policy should raise the deposit rate by 100 basis points compared to the current one. Two members of the Governing Council of the ECB gave different public answers to the question of what is the right speed to return to normal. One of them favors determination over caution, which would be in line with a 75 basis point increase this week. The other, concerned about financing conditions – perhaps understandably, given that the forward yield curve has reversed – believes that a series of multiple (ie small) steps is best practice. One way to reconcile the two positions would be to widen the interest rate corridor. The spread between the deposit rate and the marginal loan rate is quite small. Increasing the deposit rate by 50 basis points next week, while increasing the repo rate and the marginal lending rate by 75 basis points, could help to further normalize monetary conditions without unduly upsetting the financing conditions ”. (Lna)

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