BlackRock Increases Short Positions on German Bonds, Warning of "Sharp Rebound" in Inflation to Push Up Financing Costs

German government bonds are facing bearish bets from the world's largest asset manager. Funds managed by BlackRock have significantly increased their short positions in German bonds, betting that soaring European inflation will push yields beyond the 15-year high reached last week.

According to Bloomberg, Tom Becker, a fund manager at BlackRock with $6.5 billion under management, stated that over the past month since the outbreak of the Middle East conflict, he has continued to increase his short positions on 5-year and 10-year German bonds, having previously held a short position on 30-year bonds. He expects Europe to experience "a considerable rise in inflation," and that governments' expanded fiscal spending to address rising energy prices and military preparedness will lead to a significant increase in bond supply, thereby depressing bond prices and pushing up yields.

The yield on 10-year German government bonds briefly rose to a high of 3.13% last week, and has since retreated to around 3%. However, Becker believes this pullback will not last, and yields will rise again, breaking previous highs, as the market may be underestimating the fiscal response from European policymakers regarding energy security and military spending.

European Inflationary Pressure Exceeds Other Regions

Becker pointed out that Europe will face greater inflationary pressure in this energy shock compared to other regions, primarily due to its high dependence on energy from the Strait of Hormuz and its relatively fragile terms of trade.

Since the outbreak of the Middle East conflict, global crude oil prices have surpassed $100 per barrel, and the Eurozone bond market has come under pressure. Although the intensity of the sell-off in Eurozone bonds has been less severe than in the US and UK, Becker believes the inflationary shock for Europe will be more profound.

Meanwhile, several European countries have successively announced measures to reduce subsidies for consumer energy bills, and the European Commission is expected to introduce a package of measures to cope with high energy prices. This has raised market concerns that Europe might repeat the scenario from 2022-2024, when massive energy subsidies during the Russia-Ukraine conflict led to a significant expansion of fiscal deficits.

Fiscal Expansion to Boost Bond Supply

Becker's core short-selling logic lies in the expectation that fiscal expansion will lead to a larger supply of bonds. He stated that the tendency of governments "to respond to every crisis with fiscal measures and issue more debt" has been a key reason for him to consider inflation a significant risk for a long time.

"Nominal rates of 3% are not high, especially with inflation possibly exceeding targets again and more bond supply coming with greater fiscal response," Becker said. He believes that as investors begin to demand higher term premiums on long-term bonds, German 10-year yields will rise further.

Beyond German bonds, Becker is also closely watching the forward level of the 5-year German interest rate five years from now – a metric often used as an alternative reference for the 10-year yield. He believes this rate should move closer to its US and UK counterparts. Currently, the German 10-year yield is 3%, significantly lower than the 4.4% yield on US Treasuries, indicating considerable room for German bond yields to rise.

Profitable Short on UK Bonds, Shifting Focus to German Bonds

This bet is not Becker's first contrarian move. At the beginning of the year, he established short positions on US and UK bonds, at a time when the market widely expected the Federal Reserve and the Bank of England to cut rates at least twice by 2026.

The outbreak of the Middle East conflict has completely overturned these rate cut expectations. After oil prices broke $100, money market pricing indicates that the Federal Reserve will not cut rates this year, while the Bank of England and the European Central Bank are expected to hike rates at least twice each.

The reversal of fortunes has made Becker's UK bond shorts highly profitable, with his Tactical Opportunities fund's return rising by nearly 3% in the past month, while the average fund tracked by Bloomberg lost about 4%. He has now taken profits on some of his UK positions and shifted his attention to the German bond market.