If the gap closes through a broad risk-off move rather than easing stress, Deutsche Bank sees the US dollar gaining another source of support, while the euro and high-beta currencies look more exposed. The euro faces a double headwind: wider French and Italian spreads point to fragmentation risk inside the currency bloc itself. Oil is part of the inflation pressure pushing yields higher, and Deutsche Bank’s point that futures still price normalisation next year suggests energy risk may be underpriced across the curve. For equity investors, record-adjacent prices leave little cushion if credit spreads begin to catch up with sovereign stress.
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Europe’s bond market just had its sharpest sovereign shock in decades and equities shrugged, a calm Deutsche Bank says will not hold unless the stress fades fast.
Summary:
- Deutsche Bank says bond and equity markets are pricing sharply different macro outcomes.
- The French-German 10-year yield spread widened 32 basis points last week, the biggest weekly rise in Bloomberg data back to 1990, and is at its widest since 2012.
- Italy’s spread over Bunds widened 23 basis points.
- The STOXX 600 fell just over 1% and sits within 4% of its record high, while euro investment-grade credit spreads are around 100 basis points.
- Bonds are flagging high yields, faster rate hikes and oil above $100, but the VIX is subdued and oil futures still price normalisation next year.
- The bank says either stress eases quickly, as after Silicon Valley Bank in 2023, or equities and credit must reprice for weaker growth and higher default risk.
Deutsche Bank has warned that bond and equity markets are pricing two very different outcomes, after a sharp bout of European sovereign stress last week drew only a muted response from stocks and corporate credit. The bank argues the gap is unlikely to persist, and that either financial stress fades quickly or risk assets will have to reprice for weaker growth and higher default risk.
According to Deutsche Bank macro strategist Henry Allen, the spread between French and German 10-year government bond yields widened by 32 basis points last week. That was the largest weekly increase in Bloomberg data stretching back to German reunification in 1990, and it left the spread at its widest since 2012. Italy’s spread over 10-year Bunds widened by 23 basis points over the same period.
Allen said the moves resembled earlier crisis episodes, when sovereign stress was accompanied by heavy losses in risk assets. During the euro-area debt crisis of 2011 and 2012, the pandemic shock of March 2020 and the selloff of 2022, contagion in government bond markets went hand in hand with significant weakness in European equities.
This time the reaction has been far more contained. The STOXX 600 slipped just over 1% last week and remains within 4% of its record high, while euro investment-grade credit spreads ended the week at around 100 basis points, well short of the levels reached in those earlier episodes. Allen described the combination of sharply wider sovereign spreads alongside limited equity losses and only modest credit widening as highly unusual, saying rates markets were pricing contagion and a meaningful hit to growth that other asset classes had yet to reflect.
A broader Deutsche Bank assessment frames the same divergence globally. In the bank’s view, bond markets are already signalling a new macro regime of multi-decade-high yields, faster rate hikes and oil above $100 a barrel, yet equities remain close to record highs, the VIX volatility index is subdued and credit spreads show little strain. Oil futures, it notes, continue to price a return to normal conditions next year, despite repeatedly getting that call wrong.
Deutsche Bank’s conclusion is that bonds have priced the warning while risk assets have not priced the consequences. The bank pointed to the aftermath of Silicon Valley Bank’s collapse in March 2023 as the template for a benign outcome, in which stress eased rapidly. Without a similarly swift calming of conditions, it expects pressure on equities and credit to build.
This article was written by Eamonn Sheridan at investinglive.com.