Bond Traders Bet Lagarde Will Tread Carefully in Signaling Taper

(Bloomberg) -- Bond traders are betting European Central Bank President Christine Lagarde will go out of her way not to spook the market on Thursday.

At just over 100 basis points, the extra premium they demand to hold 10-year Italian bonds compared to equivalent German paper has barely budged over the past three months.

That's despite mounting speculation the ECB is going to start paring back some of the stimulus it unleashed during the pandemic, and which has helped highly indebted euro members afford big fiscal stimulus.

The positioning speaks to the belief that policy makers will take an even-handed approach in signaling any shifts to the size of their asset buying, wary that sudden or bigger-than-expected adjustments risk driving markets into a tailspin.

“They will try hard to pitch this as a recalibration of purchases from emergency settings,” said Imogen Bachra, a strategist at Natwest Markets in London, “rather than the start of a taper down to zero.”

To be sure, the market has been selling off as the chorus of hawkish voices calling for the ECB to reduce stimulus gets louder. On Tuesday, the yield on Italian and German 10-year notes rose to the highest level in around two months. 

While markets may test the ECB, its recent strategy review shows that financial stability -- which rests heavily on sovereign spreads -- has been elevated to a key priority, Bachra said.

“Higher yields might be tolerated, but higher spreads may not,” she added. Bachra is betting the Italy-German spread will continue to tighten to around 75 basis points. 

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