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11 September 2019


10y US bond yields fell 50 bps in August. But month-to-date, they are up 30 bps from their lows.

Did the bond bull market simply run too far? The answer is yes. Over the summer, massive amounts flowed into the global bond markets and pushed yields to record lows. Today, the excessive positioning and the fact that regarding the upcoming ECB decision some policy committee members shed some doubt on a dovish outcome triggered a turn-around in those bond markets. But is it a true turnaround or a simple correction? It’s too soon to tell, but the rotation this bond yield jump is triggering could have legs.

Value stocks have been hated and under-owned. Especially banks are the preferred short. That’s where the pain trade is felt most. A steepening curve and the hope for a tiering system implemented by the ECB has pushed some traders to cover their short positions. But the switch from momentum to value may have just begun, especially if the bond yields climb further. There is still a lot of doubt whether one should increase its exposure to value stocks. The economic cycle, according to some broker research reports, is still hinting at a recession and slowdown and thus favouring defensive stocks. Moreover, global portfolio managers are still positioned for a no-deal
Brexit leaving them with a big overweight defensive UK names.

Coming back to the European banking sector, tomorrow’s ECB meeting will be key. While another cut in the deposit rate looks to be a sure bet, the question is about tiering. Will the ECB implement a Swiss-style reserve tiering system, alleviating the pain for the eurozone’s banks? Excess liquidity in the eurozone sitting on banks’ balance sheets is about €2 trillion which costs around €7 billion because of negative interest rates. Another cut to the deposit rate will exacerbate this situation. So, if applied, will a reserve tiering system offset or even more than compensate for the wildly expected rate cut? This is the main question regarding this sector. Many bank CEOs have already lamented this situation, especially those from the more northern part of Europe. The banks from Southern Europe are more interested to find out what the terms would be for a third TLTRO (Targeted Long-Term Refinancing Operation).

The conclusion is that yields might have room to climb somewhat further, pushing for some additional rotation within the markets.