Europe capitulation trade in full swing on vaccine bets

London

A SUDDEN rebound in the euro and a sell-off in bond havens are forcing investment strategists to play catch-up on rising expectations for European growth.

As the currency climbs towards US$1.20, the likes of Goldman Sachs Group worry their projections for the months ahead look too gloomy. Meanwhile, BNP Paribas, Pictet and Manulife Investment are predicting that German bond yields will turn positive by December for the first time in two years.

Just weeks ago, the euro was mired in its worst start to the year since 2015, dogged by stubbornly high Covid infections and the European Union's fumbling of its vaccination programme. The yield on German 10-year bonds, the region's go-to haven, was at its deepest discount to its US counterpart in more than a year.

Now, the EU's roll-out of immunisations is getting into gear with a renewed drive to cover the bulk of its population within a few months. Meanwhile, data is turning positive and last week saw a robust climb in factory orders for Germany, the region's biggest economy.

The recovery in the single currency is set to continue, according to Charles Diebel, a money manager at Mediolanum, who says it could reach US$1.25 by year-end.

"The euro has been an underperformer against the dollar and a sterling laggard in terms of vaccine roll-out," he said "But those dynamics are shifting now, and with good news already in place in the US and the UK, Europe is catching up."

That optimism is also rippling into the bond market, squeezing German 10-year debt. Bund yields have climbed 30 basis points from this year's low to minus 0.29 per cent and Goldman Sachs sees them rising to 0 per cent. BNP Paribas predicts 0.2 per cent, the highest level since early 2019.

"The pace of vaccinations in Europe should ramp up soon," said Chris Chapman, a portfolio manager at Manulife Investment, who also expects the yield to break into posi-tive territory by year-end. "The re-opening of the economy and the catch up of the services sector will drive growth."

But with Covid infections still rising in much of Europe and just 11 per cent of the EU population vaccinated, that optimism is far from universal.

Bank of America strategist Sphia Salim sees bund yields ending the year at -0.25 per cent, though she concedes the bank's economists are more bearish than the consensus on growth and inflation. HSBC's Chris

Attfield predicts -0.5 per cent, saying most of the good news is already priced in.

Meanwhile, in an ominous sign for those placing bullish bets on the recovery, so-called speculative investors - mainly hedge funds - have cut long euro positions to the lowest in a year, according to Commitments of Traders data. The median year-end outlook for the euro among analysts contributing forecasts to Bloomberg remains at US$1.22.

Many traders are wagering on a stronger euro, however. Options betting on gains against the dollar trade at a premium over those looking for declines across tenors out to six months. Against sterling, that premium stretches to one year.

Analysts are also revising their end-2021 forecasts for German 10-year yields by the most in more than a year. BLOOMBERG

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