German election relief brief as Bund yields resume march higher

Euro zone 10-year bond yields 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.

Euro zone 10-year bond yields 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. Germany's bond yields 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 with focus returning to the prospect of major central banks taking away hefty post-pandemic stimulus as economies recover. Germany's Bund yield rose to roughly three-month peaks at -0.19%, reversing early falls to -0.24%. It was 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 election results showed the centre-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 may seek an alliance with the Greens and the liberal Free Democrats (FDP) in a "traffic light" coalition. The two parties could also team up with the conservatives in a so-called "Jamaica" coalition.

While coalition talks could drag on for weeks, investors took comfort from the fact that the election results suggest the next government would be made up of largely centrist parties with analysts anticipating more fiscal stimulus. "The SPD has held the finance department for a while and a lot of Germans have put a lot of confidence in (finance minister Olaf) Scholz and understand that fiscal policy can be used for good," said Anatoli Annenkov, senior European economist at Societe Generale.

"So the question is whether that will still hold and if it does that would be good for both Germany and Europe." European bond yields were broadly higher. Italy's 10-year bond yield rose to 0.83%, its highest in almost three months.

And U.S. 10-year Treasury yields hit 1.5% for the first time since June, 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 said last week it would likely begin reducing its monthly bond purchases as soon as November. European Central Bank President Christine Lagarde meanwhile told a European parliament committee that inflation could exceed the ECB's raised projections, but there were few signs of this already happening.

Elsewhere, the EU sold a five-year bond at an auction.

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