German bond yields higher as Fed officials downplay softer CPI

Traders are pricing around 115 bps of tightening by year end, according to Refinitiv data. Expectations for aggressive rate hikes from the Fed have also boosted bets for a large rise from the European Central Bank (ECB) in September.

After falling on Wednesday, German government bond yields were higher on Thursday, echoing moves in U.S. Treasuries, as Federal Reserve officials played down softer-than-expected inflation figures and affirmed their commitment to tighter policy. On Wednesday, a report showed U.S. consumer prices were unchanged in July from June due to a sharp drop in the cost of gasoline. Economists polled by Reuters had forecast a 0.2% rise.

U.S. Treasury yields plunged after the data but reversed course as Fed officials said further interest rate hikes were needed and it was too early to declare victory on inflation. German government bond yields followed moves in their U.S. counterparts.

"The Fed is the big player, and when rate expectations move higher or lower, you see it happen, to a lesser extent, in Europe," said Shane O’Neill, head of interest rates at Validus Risk Management. "The job isn't done and the Fed have reiterated that they are still going to be fighting inflation."

Germany's 10-year bund yield was last up 2 basis points (bps) at 0.907%. It initially fell 8 bps after the data before recouping some of the fall. Money markets are pricing in just over a 60% chance of a 50-bp hike from the Fed at next month's meeting and around a 40% chance of a 75 bp hike. Traders are pricing around 115 bps of tightening by year end, according to Refinitiv data.

Expectations for aggressive rate hikes from the Fed have also boosted bets for a large rise from the European Central Bank (ECB) in September. Traders fully price in a 50-bp rate rise next month and around 116 bps of rate rises this year, Refinitiv data showed.

Italian bonds outperformed their euro zone peers with 10-year yields down around 1 bp to 2.98%. Italy's 2-year yield fell 3 bps to 1.272%.

The closely-watched 10-year yield gap between Italy and Germany tightened to almost 205 bps, down from around 213 bps on Monday after ratings agency Moody's cut Italy's outlook to "negative" from "stable". "We had pointed out on Monday that the ratings-induced pressure won't last long," Commerzbank rates strategist Hauke Siemßen said in a morning note.

"Given the mix of ECB support combined with easing political fears and carry considerations, we maintain our constructive BTP view." The leader of the Brothers of Italy party, Giorgia Meloni, who is ahead in the polls to become next prime minister, released a video on Wednesday saying a right-wing government led by her would not threaten financial stability. Italy heads to the polls on Sept. 25.

 

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