European Central Bank: Rate path and yields after sharp rise – Societe Generale

Societe Generale strategists argue July’s global fixed income selloff looks stretched, especially in Western Europe where 2-year and 10-year yields have risen about 30bp in four weeks. They see a second European Central Bank (ECB) hike in September as priced in, but view a third move to 2.75% by February as a stretch unless Eurozone growth and second-round inflation effects strengthen materially.

Fixed income selloff seen overdone

"Has the July meltdown in global fixed income gone too far and are bearish positions at risk of a short covering squeeze and mean-reversion in yields into month-end?"

"Technically, the picture looks sombre across the main developed economies after the breakout last week but nowhere more so than in Western Europe where 2y and 10y yields are up by an average of around 30bp in the past four weeks across core and semi-core."

"That’s priced in but a third increase by next February to 2.75%, also discounted, could be a stretch unless the economy motors into a higher gear and second round inflation effects crystallise."

"This would place policy in restrictive territory by about 50bp which would add to the appeal for EUR/USD attractive provided the Warsh Fed does not tighten and oil prices come off the boil."

"So far these have been absent and until the data turns the other way, bonds and swaps are overdue some respite after the spike in 2y yields to 2.83%."