Hedge funds have increased their bets against Eurozone government bonds, expecting the European Central Bank to have limited room for further interest rate cuts this year. The total value of these bets has reached $413 billion, the highest level in more than two years. This comes as the ECB raised its inflation and growth forecasts for the year, leading to speculation of a shallow easing cycle.
Eurozone inflation rose to 2.6 percent in May, with services inflation reaching a seven-month high. The ECB now forecasts inflation to average 2.5 percent in 2024 and 2.2 percent in 2025, slightly above its 2 percent target. Despite this, the central bank has removed its explicit easing bias from its monetary policy statement and raised interest rates by 0.25 percentage points. President Christine Lagarde stated that the ECB’s decision was based on confidence in the future path, but she refrained from suggesting that the bank has entered a tightening phase.
Short positions on German government bonds, as well as Italian bonds, have increased significantly since the beginning of the year. Yields on 10-year German Bunds have risen from 2.1 percent to 2.5 percent, causing prices to fall. Italian bonds are also seeing a rise in short positioning, indicating a loss of confidence in the rally that has narrowed the gap between Italian and German borrowing costs. Despite this, some measures suggest investors remain cautiously optimistic about European bonds.
While some investors remain confident in European bonds, others prefer US government debt due to concerns about inflation in Europe taking time to recalibrate. Overall, the outlook for European bonds remains uncertain, with the market increasingly pricing in a shallow easing cycle by the ECB. It will be important to monitor how the central bank’s decisions, as well as economic data, will impact the Eurozone economy in the coming months.
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