Inflation + military spending fears may trigger a surge in eurozone bond supply! BlackRock increases short positions on German government bonds.

Asset management giant BlackRock has increased its bearish position on German government bonds, betting on a "significant inflationary uptick" in the European region, pushing borrowing costs back above the 15-year high reached last week. Tom Becker, co-portfolio manager of the $6.5 billion BlackRock Tactical Opportunities Fund, expects European governments to increase fiscal spending to help Eurozone households cope with higher energy prices and boost military capabilities. Since the outbreak of the Middle East conflict a month ago, this assessment has prompted him to increase his short positions on German 10-year and 5-year government bonds after already being short on German 30-year bonds. Becker said in an interview, "The market may be underestimating the fiscal response from European policymakers in increasing winter spending for energy security and strengthening military preparedness investments. This means that bond supply will increase in the coming quarters." As investors begin demanding higher term premiums for long-term debt, Becker expects German 10-year bond yields to surpass the 3.13% high reached last week - when escalating Middle East conflict and soaring oil prices heightened market concerns about inflationary pressures. Earlier this week, the yield slipped as market expectations rose for a ceasefire in the Middle East conflict, but it rebounded to around 3% on Thursday. Becker added that with inflation running above target levels again and fiscal expansion bringing more bond supply, a 3% yield level is "not a very high nominal rate." Since the outbreak of the Middle East conflict, selling pressure on Eurozone bond markets has been less than on US and UK bonds. However, Becker believes that due to the Eurozone's high dependence on energy transit through the Strait of Hormuz and relatively weaker trade conditions, the Eurozone will face more severe inflationary shocks than other regions. In addition, European countries have begun announcing measures to reduce consumer energy bills, and the European Commission is expected to roll out a package to address the impact of rising energy prices. These measures have raised concerns that Europe may repeat the policy path taken from 2022 to 2024 - when massive energy subsidies introduced against the backdrop of the Russia-Ukraine conflict significantly widened government fiscal deficits. BlackRock expects German yields to further rise. Becker's trading on German government bonds aligns with his long-standing view that inflation will be a significant risk factor. He emphasized in the interview that governments tend to "take fiscal responses and issue more debt with every crisis," further exacerbating his concerns. At the beginning of this year, Becker took short positions on US and UK government bonds, contrary to market consensus at the time. Investors generally believed that the Federal Reserve and the Bank of England would at least cut interest rates twice by 2026. However, the Middle East conflict pushing global oil prices above $100 per barrel broke these rate-cut bets. Currently, futures markets pricing suggests that the Federal Reserve may not cut rates this year, while the Bank of England and the European Central Bank are expected to raise rates at least twice. This shift means Becker's bet on rising UK bond yields has paid off, pushing his Tactical Opportunities Fund return close to 3% over the past month. In contrast, similar funds averaged losses of around 4%. Since then, he has closed out some profitable UK bond positions and shifted his focus to Germany. He believes that five-year German borrowing costs (as a proxy for 10-year yields) should be closer to levels seen in the US and UK five years from now. With German 10-year yields currently around 3%, significantly lower than the roughly 4.4% yield on equivalent US bonds, this suggests that there is still room for German yields to continue rising.