German election relief brief as Bund yields resume march higher

The Federal Reserve, in a hawkish tilt, said last week it would likely begin reducing its monthly bond purchases as soon as November and signalled rate increases may follow more quickly than expected. European Central Bank President Christine Lagarde appears in front of EU parliament committee later in the day.

Ten-year bond yields in the euro area rose to their highest in almost three months on Monday, as brief relief after Germany's election soon gave way to nagging concerns that major central banks could tighten monetary policy sooner rather than later. Bond yields in Germany initially fell, pushing prices up, as the tail risk of a leftist coalition taking shape after Sunday's national election faded.

However, that move quickly reversed as the focus returned to the prospect of major central banks taking away hefty post-pandemic stimulus as economies recover. Germany's Bund yield rose to -0.205%, its highest level in almost three months, reversing early falls to -0.24%. It was last up 2 basis points on the day, adding to last week's 5 bps rise.

"We don't know much yet about the make-up of the next German government but we do know that a left coalition is off the table and that's been reassuring for markets although the reaction was brief," said ING senior rates strategist Antoine Bouvet. Provisional results from Sunday's election showed the center-left Social Democrats (SPD) won 25.7% of the vote, ahead of 24.1% for Chancellor Angela Merkel's CDU/CSU conservative bloc. To secure a majority in parliament, the SPD is likely to seek an alliance with the Greens and the liberal Free Democrats (FDP) in a "traffic light" coalition, although the two parties could also team up with the conservatives in a so-called "Jamaica" coalition.

While coalition talks could drag on for weeks or even months, investors appeared comforted from the fact that the election results suggest the next government would be made up of largely centrist parties. With no fresh news for now to change that view, bond yields headed back higher with French, Dutch, and Italian 10-year bond yields all rising to their highest in almost three months.

Italian yields rose to as high as 0.82%, up around 3 bps on the day. U.S. 10-year Treasury yields also rose to their highest in about three months, with analysts citing stickier than expected inflation as a reason for rising yields.

"This is a reaction to the fact that many market participants had been too relaxed on the inflation signs, they haven't anticipated the Fed starting tapering in November," said Hans-Jörg Naumer, senior investment strategist at Allianz Global Investors. The Federal Reserve, in a hawkish tilt, said last week it would likely begin reducing its monthly bond purchases as soon as November, and signaled rate increases may follow more quickly than expected.

European Central Bank President Christine Lagarde appears in front of the EU parliament committee later in the day.