Euro zone bonds find some respite after dramatic selloff

The rise in bond yields, spurred on by fiscal stimulus hopes in the United States and a post-pandemic economic rebound that could fuel inflation, has spilled over into the euro area. Policymakers have sought to dispel fears that they would tighten policy any time soon -- the European Central Bank executive board member Isabel Schnabel reiterated on Friday that changes in nominal interest rates had to be monitored closely.

Euro zone government bond yields fell on Friday after this week's surge, although Germany's benchmark yield was still headed for its biggest monthly jump in three years as rising inflation expectations triggered a selloff of safe-haven debt.

The moves in euro zone yields on Friday were more limited than in recent volatile days, and yields on U.S. Treasuries -- which led the selloff -- dipped 5 basis points to 1.463% after rising to their highest in more than a year on Thursday. The rise in bond yields, spurred on by fiscal stimulus hopes in the United States and a post-pandemic economic rebound that could fuel inflation, has spilled over into the euro area.

Policymakers have sought to dispel fears that they would tighten policy any time soon -- the European Central Bank executive board member Isabel Schnabel reiterated on Friday that changes in nominal interest rates had to be monitored closely. Despite Friday's fall, Germany's 10-year yields, the region's benchmark, are set for their biggest monthly gain since January 2018 with a 25-basis-point rise.

On Friday, they rose as high as -0.203%, a level not matched since the COVID-19 market crash last March, before trading down 4 basis points at -0.266%, the fall extended after the Schnabel's comments. French and Austrian 10-year yields passed a milestone on Thursday, turning positive for the first time since June . They both fell around 4 basis points in early Friday trading, back in negative territory.

Investors and analysts said the bonds selloff, which has surprised many, resembled the so-called taper tantrum of 2013, when hints the U.S. Federal Reserve might slow its money printing triggered an exodus out of bonds. "The bond market just entered crisis mode," said analysts at Societe Generale, noting a 25-basis-point intraday move in U.S. Treasury yields.

"If markets fail to stabilise, central banks may have to step in, as a fast move in rates could disrupt financial conditions. With a clear medium-term trend towards higher rates, it makes little sense to attempt to catch a falling knife." LITTLE SENSE IN EURO AREA

Rising yields currently seem less justified in the euro zone, which has a weaker economic and inflation outlook and arguably needs to keep borrowing costs lower for longer. With U.S. inflation-adjusted rates still negative and the growth outlook improving, the rise in bond yields in the United States had further to run, analysts said.

By contrast, the big rise in the euro zone made little sense. The region is behind in its COVID-19 vaccination drive and economic recovery is still far from certain. "The ECB, unlike the Fed, has been actively trying to manage interest rates, or at least to slow the pace of rise," ING strategists said in a note. "We suspect intervention is imminent, or perhaps we are letting our hopes speak."

Southern European government bond yields, which have also risen rapidly as investors exited assets considered riskier than core euro zone markets, fell 1 to 5 basis points on Friday. The Italian 10-year yield declined 1 basis point to 0.787% after rising as high as 0.826% on Thursday, its highest since Oct. 1.

(Editing by Jane Merriman, Larry King)

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