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Fixed income markets saw European government bonds continue to rally in July as Central Banks increasingly evaluated dovish monetary policy to combat a weakening growth outlook and low inflation. The increased volatility during the usually quiet holiday period saw Eurex fixed income futures and options volumes 30 percent higher than July 2018.
The ECB left rates unchanged this month but signaled the potential for interest rate cuts, leading the markets to price in a September cut of 10-20bps. The Fed cut rates by 25bps with a further 25-50bps priced in by the end of the year. This has since seen 10y rates race lower.
30-day Bund volatility realized higher than implied during the middle of the month as Bunds sold off, with 10-year yields reaching -21bps before rallying in the second half of the month to lows of -44bps, a decrease of 12bps for the month. An increasing amount of European bonds saw yields become negative, which led investors to seek positive yielding assets. BTPs rallied with 10-year yields falling from 1.96% to 1.54%. The French and Italian sectors continue to outperform relative to Eurex core benchmark F&O.
Geopolitical risks continue to drive demand for safe-haven assets, with investors increasingly pricing in the probability of a no-deal Brexit, raised tensions between the U.K., U.S. and Iran, and the recommencing of U.S.-China trade negotiations. Brexit fears were increased by Boris Johnson becoming the U.K.’s new Prime Minister and stepping up the U.K.’s preparations for a no-deal Brexit. This has caused the Pound to fall from 1.27 to 1.2160 against the strengthening Dollar and from 1.1166 to below 1.10 against the Euro as Gilts rallied.
As we head into August, all eyes will be on the reopening of trade talks between the U.S. and China. Fixed Income Markets will take their direction from equities where there is increasing positioning in a move lower via volatility structures.
Lee Bartholomew, Head of Fixed Income Product R&D, Eurex