BlackRock increases short positions in German bonds: warns that a "sharp rebound" in inflation will drive up financing costs

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German government bonds are facing bearish bets from the world’s largest asset management company. BlackRock’s funds have significantly increased their short positions in German bonds, betting that surging European inflation will push yields beyond last week’s 15-year highs.

According to Bloomberg, Tom Becker, manager of BlackRock’s $6.5 billion fund, said that over the past month since the outbreak of conflict in the Middle East, he has continued to increase short positions in German bonds with five and ten-year maturities, having already held shorts in thirty-year maturities. He expects Europe to face “quite substantial inflation upside,” and governments expanding fiscal spending in response to rising energy prices and military readiness demands will significantly increase bond supply, thereby depressing bond prices and pushing yields higher.

The yield on Germany’s ten-year government bond briefly rose to a high of 3.13% last week, now falling back to around 3%. But Becker believes that this pullback will not last, yields will climb again and break previous highs, and the market may underestimate the fiscal response of European policymakers regarding energy security and military investments.

European inflation pressure exceeds other regions

Becker pointed out that Europe faces greater inflation pressure in this round of energy shocks than other regions, mainly because of its higher dependence on energy from the Strait of Hormuz and relatively fragile trade conditions.

Since the outbreak of conflict in the Middle East, global crude oil prices have surpassed $100 per barrel, pressuring the Eurozone bond market. Although the selloff of Eurozone bonds isn't as severe as in the US or UK, Becker believes that Europe will be more profoundly affected by the inflation shock.

Meanwhile, several European countries have announced cuts to consumer energy bill subsidy measures, and the European Commission is expected to launch a package to address high energy prices. This has raised market concerns that Europe might repeat the scenario from 2022 to 2024—when large-scale energy subsidies during the Russia-Ukraine conflict led to significantly expanded fiscal deficits.

Fiscal expansion boosts bond supply

The core of Becker’s short logic is that fiscal expansion will bring larger bond supply. He stated that the tendency of governments “to respond to every crisis with fiscal means, issuing more debt” is an important reason why he has long regarded inflation as a major risk.

“A nominal interest rate of 3% isn’t high, especially in the context of inflation overshooting targets again and more bond supply following greater fiscal responses,” Becker said. In his view, as investors begin demanding higher term premiums from long-term bonds, the yield on Germany’s ten-year bonds will move higher.

Outside of German bonds, Becker is also watching the forward level of Germany’s five-year rate five years from now—a measure often used as a proxy for the ten-year rate. He believes this rate should move closer to the levels in the US and UK. Currently, Germany’s ten-year yield is 3%, significantly lower than the 4.4% yield of US Treasuries, meaning German bonds still have considerable upside potential.

Profited from shorting UK bonds, shifting focus to German bonds

This bet isn’t Becker’s first contrarian move. At the start of the year, he established short positions in US and UK bonds, at a time when markets widely expected the Fed and Bank of England to each cut rates at least twice by 2026.

The outbreak of conflict in the Middle East completely overturned those rate cut expectations. After oil prices broke through $100, currency markets are now pricing in no Fed rate cuts this year, and at least two rate hikes each by the Bank of England and the European Central Bank.

This reversal enabled Becker to gain considerable profit from his UK bond shorts. His Tactical Opportunity Fund returned nearly 3% in the past month, while similar funds tracked by Bloomberg lost an average of about 4%. He has now partially taken profits in his UK positions and shifted his attention to the German government bond market.

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