Yield curve steepens as Germany's 10-year yield hits highest since March

The stronger-than-expected ADP national employment report fuelled expectations that the Federal Reserve and other major central banks may be more aggressive in tightening policy as they attempt to bring inflation back towards target. That triggered a global bond selloff, analysts said, with the U.S. 10-year Treasury yield jumping as much as 13 basis points (bps) and Germany's rising 15 bps, its biggest daily increase since the banking turmoil in March.

Germany's 10-year government bond yield rose to its highest level since March, while short-dated euro area yields fell back from multi-year highs after a sharp, global bond selloff on Thursday following strong U.S. labour market data. The stronger-than-expected ADP national employment report fuelled expectations that the Federal Reserve and other major central banks may be more aggressive in tightening policy as they attempt to bring inflation back towards target.

That triggered a global bond selloff, analysts said, with the U.S. 10-year Treasury yield jumping as much as 13 basis points (bps) and Germany's rising 15 bps, its biggest daily increase since the banking turmoil in March. Bond yields move inversely to prices. Germany's 10-year yield, seen as the benchmark for the euro area, was last up 2.5 bps at 2.651%, after hitting its highest since March 9 at 2.662%.

"It's a U.S.-driven story at the moment. The euro area has been lagging in this cycle so you tend to interpret that what happens in the U.S. will happen in the euro area with a lag," said Jan von Gerich, chief analyst at Nordea. "I think it was an over-reaction yesterday, especially what happened with European bonds ... but when there is a lack of important euro area data and you have summer markets then it's easy to be driven by what happened in the U.S."

Liquidity tends to be poorer than usual in the summer months, intensifying moves further, von Gerich added. Germany's two-year yield, sensitive to changes in interest rate policy, was down 2 bps at 3.338% after rising 7 bps on Thursday to its highest level in 15 years at 3.393%.

This meant the German yield curve steepened, thereby lessening the inversion, with the gap between 10- and two-year yields tightening to negative 69 bps after hitting its lowest since 1992 on Monday of negative 91 bps. The curve was set to end the week steeper for the first time since May.

The yield curve inverts when shorter-dated bonds have higher returns than longer-term ones, suggesting that while investors expect interest rates to rise in the near term, they believe that higher borrowing costs will eventually hurt the economy, forcing central banks to later ease monetary policy. Italy's 10-year bond yield, often seen as a benchmark for the euro zone periphery, rose 1 bp to 4.39% adding to a 22.5 bps rise on Thursday, its biggest daily increase since mid-December.

This meant the gap between Italian and German 10-year yields stood around 173 bps. Italy's two-year yield was down 2 bps to 3.991% after rising 13 bps on Thursday to its highest level since 2012.

The U.S. Labor Department's closely watched employment report was set to take centre stage on Friday, with job growth expected to slow and the unemployment rate seen falling to 3.6%. "Labour market data is likely to become much more important than inflation data going forward," said Mohit Kumar, chief financial economist Europe at Jefferies.

"Inflation is likely to follow a predictable path with headline coming lower and core remaining sticky. But the main question for the central banks and markets would be when the economy is starting to show reasonable signs of a slowdown." January 2024 European Central Bank euro short-term rate (ESTR) forwards rose to 3.95%, implying market expectations for a deposit rate of over 4% by the beginning of next year. The rate is currently 3.5%.