Euro zone government bond yields rise as safe-haven demand recedes

Iran's weekend missile and drone attack caused only modest damage in Israel, and Washington said it did all it could to avoid open warfare erupting between the two countries. The 10-year government bond yield, the euro zone's benchmark, was up 7.6 basis points (bps) at 2.43%, after dropping 11.8 bps on Friday in its biggest daily fall since Oct. 9, the Monday after Palestinian Islamist group Hamas attacked Israel.

Euro zone government bond yields rose on Monday after plunging on Friday, amid calls for restraint in the Middle East and some let-up in fears of an immediate escalation. Iran's weekend missile and drone attack caused only modest damage in Israel, and Washington said it did all it could to avoid open warfare erupting between the two countries.

The 10-year government bond yield, the euro zone's benchmark, was up 7.6 basis points (bps) at 2.43%, after dropping 11.8 bps on Friday in its biggest daily fall since Oct. 9, the Monday after Palestinian Islamist group Hamas attacked Israel. Bond prices move inversely with yields. "Friday moves was driven by risk aversion as the market tried to position for any possible escalation over the weekend," Mohit Kumar, chief European economist at Jefferies, said.

"Markets will be relieved that the situation did not escalate further and no casualties were reported. However, we expect markets to trade with a cautious tone over the coming days". Borrowing costs in the euro area extended their rise, mirroring U.S. Treasuries, after stronger than expected U.S. retail sales data on Monday suggested consumers are weathering high interest rates, reducing the need for rate cuts.

The U.S. benchmark 10-year yield reached 4.66%, its highest since November. Analysts said if Bund yields saw upward pressure from developments in U.S. Treasuries, financial conditions could be overly tight in the euro zone, and the European Central Bank would have to respond with easier monetary conditions.

The gap between the 10-year U.S. Treasury and German rates climbed to 220, its highest since December 2019 as yields rose more in the U.S. than in the euro area, with markets expecting the Federal Reserve to be more hawkish than the ECB. While Fed officials reiterated there was no urgency to cut rates and supported expectations for two Fed moves this year, ECB rate-setters argued the ECB could ease its monetary policy even if the Fed does not.

Lithuanian ECB policymaker Gediminas Simkus said there was a greater than 50% probability of more than three rate cuts in 2024. Francois Villeroy de Galhau said the ECB was confident of winning the inflation fight, while ECB chief economist Philip Lane said inflation was heading to 2% after a bumpy road. Money markets are pricing in 83 bps of ECB rate cuts in 2024 from 87 bps late on Friday.

Derivatives on U.S. rates price in 40 bps of rate cuts in 2024, discounting a 60% chance of a second rate cut this year from around 50% last week after U.S. inflation data. Italy's 10-year yield, the benchmark for the euro area's periphery, rose 9.7 bps at 3.839%.

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