Why This Week Could See Start of Risk-Off

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
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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.


Mike Gallagher is director of research at IDEAglobal.