'Fear and greed' European bond rally likely to fade - Franklin Templeton

By Naomi Rovnick

LONDON (Reuters) - A historic dash into safe-haven government bonds following the collapse of U.S. lender Silicon Valley Bank (SVB) last week will prove short lived, one of Europe's biggest bond investors said on Tuesday.

David Zahn, head of European fixed income at Franklin Templeton, said he was positioned against interest rate risk since high inflation would likely keep the likes of the European Central Bank (ECB) in hiking mode.

Germany's two-year bond yield, sensitive to interest rate expectations, plunged 37 basis points on Monday in its biggest daily fall since 1995, as investors rapidly repriced rate-rise bets.

Yields rose on Tuesday, meaning their prices fell, along with U.S. peers, but remained well below levels from before SVB's lightning collapse.

"We were in that spiral of fear and greed," said Zahn, who runs funds worth 5 billion euros ($5.36 billion).

"People were just panicking," he added, referring to Monday's moves.

Zahn said he expected euro zone bond yields to go back to where they were about two or three weeks ago.

"We have shortened up some into this rally," he said, adding he has used futures or cashed out on positions in order to take a broad position of yields rising from here, as the ECB presses on with rate hikes at its March 16 meeting and beyond.

The ECB will want to counter the bond rally as it represents "a big easing of financial conditions" at a time of high inflation, Zahn said.

He expected the ECB to raise rates to a peak of 3.5% or 3.75% and then keep them there.

The ECB has raised its main rate by 3 percentage points since July to 2.5%.

Zahn expected U.S. banking issues to have a "muted" impact on Europe.

An index of European banking shares has dropped around 3.5% this week, while the U.S. KBW regional banking index has lost over 7% even after strong gains on Tuesday.

($1 = 0.9334 euros)

(Reporting by Naomi Rovnick; editing by Dhara Ranasinghe and Josie Kao)