European Equity Strategy:Stoxx 600drops 5%,as the goldilocks gap starts to close
Has the Bund yield overshot? Euro area PMI momentum (the 6-month change in the Euro area composite PMI new orders) is a key driver of moves in the German 10-year bond yield. At 74bps, the Bund yield is now 5-10bps above the fair-value implied by its relationship with PMI momentum. Such an overshoot is typically explained by rising Euro area core CPI. Yet, the January reading out last week showed it had in fact fallen by 17bps over the past 6 months. This leaves monetary policy as the likely driver of the overshoot of Bunds relative to growth momentum, consistent with the 20bps rise in real bond yields over the past couple of weeks. Assuming no further hawkish turn in market expectations for monetary policy, the Bund yield should face downside pressure over the coming months, given our expectations for a fade in Euro area PMIs and DB house view on core CPI. This is consistent with the projection by DB’s rates strategists, who are targeting afor the Bund yield by the middle of the year. A renewed fade in Bund yields would likely boost the relative performance of European(we are overweight), especially relative to(we are benchmark).