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Why This Week Could See Start of Risk-Off

Mike Gallagher, Director of Research, IDEAglobal
Monday, 20 May 2013 | 12:00 AM ET

We have seen bouts of reality emerging in phases, which have subsequently been washed over by the relentless search for yield, Slovenia's bond issue last week being a classic example. However, the deteriorating economic and political triggers in Europe appear likely to cause a bout of serious risk-off, starting early this week.

Specifically, we expect Italian and Spanish 10-year yields to begin a move higher early next week, until at least October 2013. In this period, these important yardsticks are seen trending higher, with spikes and corrections, but with a higher bias. Our model shows these yields at least 100 basis points higher by the end of October 2013, at levels consistent with a fundamental shift in current thinking among asset managers with regard to the stability of Europe. Italian political risks and Spanish social unrest risks are paramount.


ECB President Mario Draghi
Getty Images
ECB President Mario Draghi

The decline, led by the Italian and Spanish markets, is projected to cause 10-year German Bund yields to trade atnew lows by the end of June. Our October 2013 level for Bund yields remains at 5 basis points either side of 1 percent.

In addition, we forecast the pan-European Euro Stoxx 600 and German DAX indexes will drop by about 10 percent by mid-July and the European banking index will trade back towards 153 point lows.

The euro-dollar exchange rate will fall to the $1.26 handle by early-July, and then $1.23 in the period between late-August and late-September.

In conclusion, the "Draghi put" which was established in August 2012 when the euro-dollar exchange rate was at 1.21, is likely to virtually evaporate.

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Mike Gallagher is director of research at IDEAglobal.

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