European bond yields at 15-year highs amid inflation, rate hike fears
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Thursday saw the yield on Germany’s 10-year bund — a benchmark for the euro zone — surge to the highest level since mid-2011 at the height of the euro crisis. On Friday morning, the 10-year bund added a further 6 basis points to trade at 3.1228%, holding above that 15-year high.
Bond yields and prices move in opposite directions, and one basis point equals 0.01%.
Yields on French government bonds, known as OATs, also extended gains on Friday, with the country’s 10-year bond adding 9 basis points to also hover at their highest level since 2011. The previous day, the 10-year OAT surged by around 14 basis points.
Last week, U.K. government borrowing costs hit their highest levels since the 2008 financial crisis, with yields on British gilts spiking as investors rushed to price in a resurgence of inflation and bets on more hawkish policy from the Bank of England.
Benchmark 10-year U.K. government bond — or gilt — yields were up by another 10 basis points at 5.07% on Friday, having added 83 basis points over the last month.
The sharp sell-off followed a speech from European Central Bank chief Christine Lagarde, who said the ECB was prepared to raise its key interest rate even if inflation spikes brought on by the U.S.-Iran war were short-lived.
They were also accompanied by sharp moves in bonds issued by other euro zone economies, including Spain, Italy, Portugal, Greece, Poland, the Netherlands and Belgium.
In an interview with The Economist published the same day, Lagarde labeled market views of a swift recovery from the Iran war “overly optimistic,” telling the publication that there is “no way” the Gulf’s lost energy supply can be restored within months. The disruption may last years, she warned.
Before the Iran conflict erupted in late February, the euro zone’s inflation rate had dipped below the central bank’s 2% target. In February, however, the rate ticked up to 1.9%.
The war, and the subsequent blockade of the Strait of Hormuz — a key shipping route — have sent global oil and gas prices skyrocketing and upset European inflation forecasts. The continent is reliant on energy imports, and is still reeling from an energy shock caused by the Russia-Ukraine war and sanctions on Russian exports.
Markets are currently pricing in more than a 90% chance of the ECB hiking interest rates by June.
On Friday, Spain published flash inflation data, the first inflation print to come out of the euro zone since the U.S.-Iran war started in late February.
The annual inflation rate hit 3.3%, the data showed, lower than the 3.7% expected by economists polled by Reuters.
However, there are some signs that the war is beginning to have an impact on economic activity across the continent. This week, a GfK survey showed German consumer confidence had taken a hit, with respondents anticipating a hit to their incomes amid rising inflation fears. In the corresponding survey for the U.K., published Friday, analysts said expectations of sharp price rises were driving a “ripple of fear” among British consumers.
Yields will peak when energy prices peak
“Growing fears of a stagflationary shock [have] weighed on bond markets, with some huge moves for European sovereigns in particular,” Deutsche Bank’s Jim Reid wrote in a Friday morning note.
He added that, in light of the ongoing conflict, Deutsche Bank’s European economists had updated their inflation forecasts to an annual rate of 2.58% for March from a previous forecast of 1.89%.
James Bilson, global unconstrained fixed income strategist at Schroders, told CNBC energy prices were “still by far and away” the most significant driver of movement in European bond markets.
“Calling a top in yields is like catching a falling knife — it’s hard to escape the simplistic conclusion that yields will peak when energy prices peak,” he said via email on Friday.
“The ECB outlined three scenarios in their forecasts last week: ‘baseline,’ ‘adverse’ and ‘severe.’ At current prices we are between the baseline and the adverse, but moving towards the ‘adverse’. We see that as consistent with the ECB hiking rates at least a couple of times. If energy prices move us towards the ‘severe’ scenario, all bets are off.”
Arend Kapteyn, global head of economic and strategy research at UBS, told CNBC’s “Squawk Box Europe” on Friday that the moves in the bond market reflected a “bear flattening,” where yields on bonds with shorter maturities rise notably.
“If you go into a recession, then we’re going to see massive bull steepening again, [where] basically these front ends come back down,” he said. “If you go to say, $130 oil, and your landing zone is at, let’s say, $100, then I really think 10-year yields are going to get stuck at … three or a bit above three [percent]. But in a scenario where potentially the Fed starts cutting, then these bond yields could come all the way back down.”
Money markets are currently pricing in a 93.8% chance of the U.S. Federal Reserve holding interest rates steady at its next meeting in April, according to the CME’s FedWatch tool.
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