Euro zone bond yields jump after Powell’s hawkish comments

Euro zone government bond yields rose on Tuesday as investors priced in more aggressive monetary tightening from the Federal Reserve to tame rising inflation.

Federal Reserve Chair Jerome Powell delivered his most muscular message to date on his battle with inflation, saying it might move “more aggressively” to raise rates to keep an upward price spiral from getting entrenched.

Germany’s 10-year government bond yield, the benchmark of the bloc, rose 6 bps to 0.51%, its highest since October 2018.

US 10-year Treasury yield rose 1.5 bps to 2.333% in early London trade, after hitting its highest since May 2019 at 2.346% overnight.

Money markets are pricing in around 190 bps of US interest rate hikes by year-end, including an 80% chance of a 50 bps hike in May, which would bring the rate increase of 2022 to 215 bps.

Euro zone bond yields rise, wary on negotiations over Ukraine

“Last time we saw more than 200 bps of hikes in a calendar year was back in 1994 (when rates rose +250bps), so again, a pace of tightening that’s potentially faster than anything else in the last 3 decades,” Deutsche Bank analysts said.

Powell noted that “in 1965, 1984 and 1994, the Fed was able to raise rates without triggering a recession, and pointed out that others were not induced by monetary policy,” they added.

Money markets also bet on around 50 bps of rate hikes by the European Central Bank by December 2022.

The ECB’s president Christine Lagarde made clear on Monday that the world’s two top central banks will move out of sync in the foreseeable future, but more hawkish comments suggested that rate hikes might be needed this year.

Bundesbank President Joachim Nagel said that the European Central Bank should continue to normalise policy and raise interest rates, possibly as soon as this year, if the inflation outlook warrants it.

“What is clearer is that (the Fed’s hawkish turn) has implications for bond demand far away from the US shores,” ING analysts said in a research note.

The spread between German and US 10-year yields widened by 1.5 bps to 183.5 bps.

Meanwhile, investors continue watching for any positive signal from Ukraine, but the question of territory could remove any chance of an agreement to end the war.

Italy’s 10-year government bond yield rose 6 bps to its highest since April 2020 at 2.04%; the spread between Italian and German yields widened to 153 bps.