Bond yields have climbed rapidly this week as investors grow increasingly nervous about the prospect that interest rates might stay higher-for-longer in the US.
Yields on the 10-year UK Gilt climbed just over 15 basis points yesterday while the yield on 10-year bonds in Germany, Italy and France all rose around 10 basis points. Government debt staged a modest recovery today, but not enough to erase Tuesday’s sell-off.
These moves followed a sharp rise in US Treasury yields on Monday, when European markets were closed. Yields on the 10-year Treasury climbed over 10 basis points on Monday before rising another four basis points on Tuesday.
“European bonds dropped, tracking the previous day’s selloff in Treasuries, as traders priced the possibility of fewer interest-rate cuts from the Fed,” analysts at Liberum noted.
Yields and prices move inversely, meaning if bonds sell-off then the yield will rise. The yield reflects the cost of borrowing and it is closely tied to market expectations for where interest rates are heading.
Markets are anxious that the US Federal Reserve will have to leave rates on hold a little longer after a string of releases revealed the US economy shows no sign of slowing down.
Last Friday, when markets were closed, the core personal consumption expenditure (PCE) index – the Fed’s preferred measure of underlying inflation – showed that prices increased 0.3 per cent in February. Although this was in line with expectations, it suggests price pressures are still running hot.
Later that day Jerome Powell, chair of the Fed, signalled that the central bank was in no rush to cut rates.
Then, on Monday, data showed that the US manufacturing sector performed ahead of expectations, returning to growth after one and a half years of contraction.
Together these factors have made investors less sure that the Fed will start cutting interest rates in June. Last month a June cut looked nearly certain, but now there is only a 60 per cent probability of a cut.
This prompted the sell-off in US government debt bonds, which filtered through into European markets even though markets are still fairly sure the ECB and Bank of England will start cutting in June.
“Eurozone yields had some catching up to do on Tuesday,” analysts at ING said. “US yields are the clear driver here since the eurozone data does not show the same strength that would argue for a revaluation of long run rates,” they continued.
Figures out this morning showed that Eurozone inflation came in below expectations in March, easing the path for a June cut.
The bloc has struggled to generate any real economic momentum over the past few months meaning the ECB faces fewer risks about an overheating economy.
Read more
Cost of government debt falls as investors seek out a safe haven and rein in rate expectations