German Bond Market Hinting at Potential Economic Downturn

Yield curve inversions can be reliable indicators of economic downturns. This means that traders in European equities may want to pay close attention to the German bond market.

Amid global inflation, central banks have been pushing rate hikes to the limit. They are also keeping in mind that a recession could potentially be the byproduct of too much monetary policy tightening. Investors in German bonds predict that rate hikes instituted by the European Central Bank (ECB) will push the Eurozone into a recession.

“Investors in German debt are increasing their bets that the European Central Bank’s interest rate rises will push the European economy into a deeper downturn, as a closely watched recession indicator hit its most extreme level since 1992,” a Financial Times article noted, pointing out that the spread between two-year and 10-year yields reached a 31-year low.

The article did note that the spread widened following remarks from Christine Lagarde, president of the European Central Bank. Lagarde essentially said that inflation is proving to be more stubborn than originally anticipated. As a result, more rate hikes by the ECB are expected to keep inflation under control.

“The message that is coming is pretty clear,” said Lyn Graham Taylor, a senior rates strategist at Rabobank. “The market believes that the ECB will be determined to stick with higher rates and markedly slow the economy by doing so.”

Leveraged ETF Up Despite Potential Headwinds

Despite these macroeconomic concerns, the Direxion Daily FTSE Europe Bull 3X ETF (EURL) is up over 20% for the year, riding the overall rally in 2023 after a bearish 2022. Traders could use an area of value as an entry point if the Eurozone economy does experience a downturn. That’s especially true if European markets shrug off macroeconomic headwinds and continue to trend higher.

EURL seeks daily investment results equal to 300% of the daily performance of the FTSE Developed Europe All Cap Index. The index itself is a market capitalization-weighted index. It is designed to measure the equity market performance across market caps in developed markets in Europe.

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