Should traders be worried about the ECB and fragmentation risk?

What is fragmentation risk?
What’s happening with euro fragmentation now?
How to trade euro fragmentation

What is fragmentation risk?

Fragmentation risk is the possibility that some peripheral and debt-laden Eurozone countries might experience a significant rise in their bond yields relative to a benchmark, such as German 10-year bunds. If yields widen sharply, this will raise borrowing costs in these countries to the point where it might trigger another European debt crisis.

Bond yields across the Eurozone have surged higher over the past few weeks, with those of Italy sharply outpacing the rest of the region. The ECB’s June policy meeting exacerbated those moves after it suggested a more aggressive policy tightening – but failed to deliver any new measures to support highly indebted nations in the bloc.

With the ECB halting bond purchases, traders fear that demand for debts of high-risk countries in the Eurozone will fall, resulting in even higher yields in order to attract investors. In June 2022, the 10-year BTP-Bund spread widened to around 40 basis points to approach levels last seen at the peak of the pandemic-induced market turmoil in 2020.

The ECB cannot be too aggressive in tackling inflation as its actions could exacerbate fragmentation risks. There is even a risk therefore that the current situation with stagflation might worsen. The ECB must therefore find new ways to normalise its monetary policy without causing damage to peripheral countries in the Eurozone.

Should it fail, the market turmoil would be significant – with indices, FX pairs, bonds and stocks all affected. Take your position on the price action with a FOREX.com account.

What’s happening with euro fragmentation now?

Markets sighed relief on Wednesday after the ECB announced an emergency meeting to address fragmentation risks. There was a lot of hope ahead of that meeting, as evidenced by the euro climbing back to 1.05 handle on the session.

But as it turned out, the central bank didn’t go far enough. It sent out an underwhelming statement relating to re-investing its pandemic emergency purchase programme (PEPP), adding that it has tasked its staff to look into designing a new tool to deal with fragmentation risks.

Still, that was enough to cause a rally in downbeat Italian bonds, causing their yields to drop sharply as investors’ expectations about risks of fragmentation fell. In truth, the rebounding BTPs were probably more to do with short covering than investors rushing to buy Italian debt. EUR/USD also fell back to near 1.04 handle because if the ECB does apply “flexibility in reinvesting redemptions coming due in the PEPP portfolio,” this is effectively a form of quantitative easing (QE), meaning the disparity between Eurozone and US monetary policies will continue to grow larger.

So, investors saw at least some hope that we are not heading to those dark days of Eurozone debt crisis again as the ECB’s promise to do more alleviated some fears. However, the optimism appears to have been short-lived as by Thursday, European markets – including Italian stocks – were heading down again:

Indeed, there are a few issues that are not addressed. For one thing, the ECB is constrained by the German constitutional court. For another, reinvesting PEPP is far from a permanent fix. As soon as the markets realise these factors, the Italian and Eurozone peripheral bond market sell-off might resume.

Clearly, more is needed to be done. The ball is in their court, and markets will push for an answer. So, the risk of a full-blown debt crisis issue in Europe is not completely eliminated.

How to trade euro fragmentation

Fragmentation is a risk to bonds, equities, indices and the euro. For investors, this is something they could do without. Traders, on the other hand, will not be too bothered since they seek to make profit from both rising and falling markets. If anything, more volatility is good for traders, but bad for investors.

You can take advantage of the volatility caused by fragmentation risk with a free FOREX.com account, which enable you to go long and short on stocks, indices, FX pairs and more. To get started, follow these steps:

Open your account. It’s free and takes less than five minutes
Add some funds so you can start trading instantly
Choose to go long or short on 1,000s of global markets

Alternatively, you can trade risk free using a FOREX.com demo, featuring virtual funds and live prices on our full range of markets.

StoneX Europe Ltd makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied. You should always seek independent advice as to your suitability to speculate in any related markets and your ability to assume the associated risks, if you are at all unsure. We are not under any obligation to update any such material. Any opinion made may be personal to the author and may not reflect the opinion of StoneX Europe Ltd.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Please ensure you fully understand the risks involved by reading our full risk warning.

FOREX.com is a trading name of StoneX Europe Limited, and FOREX.com/ie is a domain operated by StoneX Europe Ltd, a member of StoneX Group Inc. StoneX Europe Ltd, is a Cyprus Investment Firm (CIF) company registered to the Department of Registrar of Companies and Official Receiver with a Registration Number HE409708, and authorized and regulated by the Cyprus Securities & Exchange Commission (CySEC) under license number 400/21. StoneX Europe is a Member of the Investor Compensation Fund (ICF) and has its registered address at Nikokreontos 2, 5th Floor, 1066 Nicosia, Cyprus.

StoneX Europe Limited is registered with the German Federal Financial Supervisory Authority (BaFin). BaFin registration ID: 10160255

FOREX.com is a trademark of StoneX Europe Ltd, a member of StoneX Group Inc.

The statistical data and the awards received refer to the Global FOREX.com brand.

This website uses cookies to provide you with the very best experience and to know you better. By visiting our website with your browser set to allow cookies, you consent to our use of cookies as described in our Privacy Policy.

Through passporting, StoneX Europe is allowed to provide its services and products on a cross-border basis to the following European Economic Area ("EEA") states: Austria, Bulgaria, Croatia, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden.

Additionally, StoneX Europe Ltd is allowed to provide Investment and Ancillary Services to the following non-EU jurisdiction: Switzerland.

StoneX Europe Ltd products, services and information are not intended for residents other than the ones stated above.

Tied Agent Information: KQ Markets Europe Ltd with Company No. HE427857.
Address: Athalassas 62, Mezzanine, Strovolos, Nicosia Cyprus.
Services Provided: Reception and Transmission of Orders.
Commencement Date: 06/12/2022
Website: KQ Markets - CFD Trading | KQ Markets

We may pay inducements, such as commissions or fees, to affiliates or third-party introducers for referring clients to us. This is in line with regulatory guidelines and fully disclosed where applicable.

StoneX Europe Ltd may make third party material available on this website which may contain information included but not limited to the conditions of financial markets. The material is for information purposes only and does not contain, and should not be construed as containing, investment advice and/or investment recommendation and/or an investment research and/or an offer of or solicitation for any transactions in financial instruments; any decision to enter into a specific transaction shall be made by the client following an assessment by him/her of their situation. StoneX Europe Ltd makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied. You should always seek independent advice as to your suitability to speculate in any related markets and your ability to assume the associated risks, if you are at all unsure. We are not under any obligation to update any such material. Any opinion made may be personal to the author and may not reflect the opinion of StoneX Europe Ltd.