Fed pushes euro zone bond yields higher, Italy sees relief

Euro zone bond yields followed suit and Germany's 10-year yield, the benchmark for the bloc, was up 2 basis points by 1121 GMT to -0.05% after rising as much as 4 bps in earlier trading. The euro markets "were already in an optimistic place for hiking in 2022," said Peter McCallum, rates strategist at Mizuho.

Euro zone bond yields rose on Thursday as bets grew on a more hawkish U.S. Federal Reserve, while Italian bonds recovered as the country's main political blocs indicated wanting to speed up consultations on a presidential candidate. The Fed said on Wednesday it is likely to hike interest rates in March and reaffirmed plans to end its bond purchases that month in what the central bank's chief Jerome Powell said would be a sustained battle to tame inflation.

Much was left undecided, including the pace of subsequent rate hikes or how quickly officials will run off the bank's massive balance sheet. Powell's hawkish tone pushed short and medium-dated Treasury yields higher as investors ramped up their rate hike bets to price nearly a full probability of five rate hikes this year, compared to four before the Fed meeting.

Moves were also mirrored in euro zone markets, though to a lesser extent. The bloc's money markets moved back to fully pricing in two, 10 basis-point rate hikes from the European Central Bank by then. Euro zone bond yields followed suit and Germany's 10-year yield, the benchmark for the bloc, was up 2 basis points by 1121 GMT to -0.05% after rising as much as 4 bps in earlier trading.

The euro markets "were already in an optimistic place for hiking in 2022," said Peter McCallum, rates strategist at Mizuho. "It's hard for the market to react excessively again but we have had a bearish reaction".

Market pricing for ECB hikes this year is at odds with the bank's economic projections and most economists also don't expect such a move. A key market gauge of long-term euro zone inflation expectations fell to the lowest since late November at 1.8024% as bets on monetary policy tightening continue to cut inflation expectations.

Elsewhere, Italian bonds outperformed slightly after an earlier underperformance. The 10-year yield was last down 1 bp to 1.39% after rising to the highest since June 2020 at 1.463% in earlier trade. Though a fourth round of voting to elect a new Italian president was headed for failure on Thursday, the main political blocs indicated wanting to speed up consultations and former prime minister Matteo Renzi predicted a deal would be reached by Friday.

Uncertainty around the vote, which has thrown into doubt whether former ECB president Mario Draghi's government will endure, has spurred volatility in Italian debt in recent sessions and pushed the risk premium over German bonds to the highest since September 2020. "The risk beforehand was that this drags on a bit and uncertainty takes place over a longer period," McCallum at Mizuho said.

"If we are going to get a resolution by Friday I suppose people are trying to pre-empt that a bit." The risk premium, after rising to a new September 2020 high at over 150 bps in earlier trade, was last down to 144 bps.

 

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