(Bloomberg) — Some of Europe’s biggest asset managers say traders are wrong to believe that the European Central Bank is done raising interest rates.
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As a net importer of energy, the region is particularly exposed to rising prices if the Middle East crisis intensifies, and the market is likely to decline, according to Legal & General Investment Management, Vanguard Asset Management and Robeco Group. They say they are underestimating the possibility of further tightening in response. . For this reason, government bonds with short maturities are particularly vulnerable.
This view clashes with the ECB’s suspended swap pricing, which was effectively baked in this week, with only a 10% chance of a 25 basis point rate hike at the subsequent Governing Council meeting. In the US, swaps show there is a 40% chance the Federal Reserve will raise interest rates by another quarter of a point.
“Europe is more vulnerable here than other developed markets,” said Christopher Jeffrey, head of interest rate and inflation strategy at Legal & General, which manages 1.3 trillion pounds ($1.6 trillion) of assets. ” he said. “The ECB is a central bank that may feel the need to overshoot.”
At the same time, ECB President Christine Lagarde and others will need to carefully consider the economic impact of raising interest rates, even if energy price increases are extended. Italy’s debt burden makes the EU’s third-largest economy particularly vulnerable in the face of tightening policies.
Brent crude oil prices have risen by more than 10% since Hamas’s Oct. 7 attack on Israel, amid concerns that a major fire could spread. The disruption of major transport routes such as the Panama Canal and extreme weather events that are wreaking havoc on the supply of staple foods are contributing to worsening inflation conditions in Europe.
The ECB’s sole mandate of price stability also makes European policymakers more likely to raise interest rates in the face of rising energy costs. Its Fed counterpart is responsible for promoting maximum employment and keeping prices in check.
Ales Koutny, head of international rates at Vanguard, agrees with market pricing suggesting the ECB will keep rates on hold on Thursday, but traders are concerned that further tightening could occur in the coming months. He said he was too satisfied with his sexuality. The firm oversees $1.9 trillion in actively managed fixed income assets worldwide.
“The market is underestimating the possibility of further interest rate hikes by the ECB,” Koutney said. Until last week, “the Fed was no different.”
One of the arguments in favor of pausing interest rate hikes is Italy’s worsening fiscal situation as growth slows. Further tightening would put pressure on economic activity, further pushing up the country’s risk premium and putting it at risk of sliding into a debt crisis.
Gabriel Makhlouf, a member of the ECB’s executive board, said earlier this month that the spread between Italy’s government bond yields and that of its peers is “definitely something that officials are paying very close attention to.” The difference in 10-year bond yields between Italy and Germany recently exceeded 200 basis points, a widely watched level.
Commerzbank interest rate strategists led by Christoph Rieger wrote that the ECB is probably much closer to the pain threshold than the Fed, as the eurozone economy is already in distress and the spread between BTP and German government bonds has widened sharply. It’s getting closer.” They predict that ECB interest rates have peaked.
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But those who think rate hikes are not over yet emphasize that there are other factors at play. Colin Graham, head of multi-asset strategy at Robeco, said further stimulus from China would also add to new price pressures in the region.
“We definitely think the ECB should raise rates further,” Graham said. “Inflation is still out of control.”
–With assistance from Aline Oyamada and James Hirai.
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