Euro zone yields edged lower on Monday as bond markets consolidated after monetary tightening expectations drove German borrowing costs to their highest since February 2018.
Most analysts expect German yields to stay around the current levels in the short term, as the downside risks to the economy due to the Ukraine conflict will moderate the European Central Bank’s (ECB) commitment to tame inflation.
Germany’s 10-year government bond yields, the benchmark of the bloc, fell 1 basis point (bps) to 0.55%.
Investors watched for ECB speakers after German yields in March set their most significant monthly rise since 2009. “Even if driven primarily by energy, the March 7.5% harmonised index of consumer prices (HICP) print will probably prevent (ECB officials) from pushing back against, excessive in our view, rate hike expectations,” ING analysts said in a note. Money markets are currently pricing in almost 60 bps of ECB rate hikes by year-end.
“It is notable that even the hawks are not advocating Fed-style shock therapy,” ING analysts said.
The spread between German and US 10-year yield, a gauge of monetary divergence between the two sides of the Atlantic, widened by 3 bps to 186 by 0741 GMT on Monday, but was still below March 28’s 196.38, its highest since April 2021.
US two-year Treasury yields briefly hit their highest since early 2019 in early London trade on Monday on expectations that the Federal Reserve will deliver bigger rate hikes in the months ahead to tame inflation.
“The coming sessions will show whether Bunds can continue to defy the bearish US Treasury curve inversion dynamics,” Commerzbank analysts said in a note to clients.
“The track record of the US curve is scary. An inverted curve correctly predicted every recession over the last 60 years, including the latest recession caused by the (coronavirus) pandemic,” they added.
The Federal Reserve will need to keep a careful eye on how the economy reacts as it raises interest rates, and scale the pace of its rate increases accordingly, New York Fed President John Williams said on Saturday. According to Commerzbank, the current forward pricing sees Fed rates going above the “neutral” level, which the Fed estimates at 2.4%.
The neutral rate is the interest rate that supports the economy at full employment and maximum output while keeping inflation constant.