Markets cautious after ECB remarks drive Bund yields close to 12-year high

Investors turned cautious after the euro area's benchmark 10-year Bund yield approached its highest levels in over 12 years as European Central Bank officials reiterated that rates would stay at current levels for an extended period to tame inflation.

Investors turned cautious after the euro area's benchmark 10-year Bund yield approached its highest levels in over 12 years as European Central Bank officials reiterated that rates would stay at current levels for an extended period to tame inflation. Centrist ECB policymaker Francois Villeroy de Galhau said the ECB would keep rates at 4% for as long as needed after some policy hawks recently called for rates to stay at high levels for longer without ruling out an additional hike.

Money markets keep pricing an around 30% chance of an additional ECB rate hike by the year-end. "Investors are in no rush to put cash to work," said Christoph Rieger, head of rates research at Commerzbank.

"While most seem to agree that interest rates are at their top, there is no urgency to lock in lower rates further out on the curve," he added. Bund yields were down one basis point (bp) at 2.70% on Tuesday. They reached the highest level since the summer of 2011 at 2.77% in early March.

"Overall, it seems that the recent sell-off (in Bund) might be running out of steam," Citi analysts said after arguing that Bunds hit technical support. Markets are also awaiting the outcome of the Federal Reserve policy meeting late on Wednesday, with a poll of academic economists expecting the U.S. central bank to defy market forecasts and raise rates by 25 basis points (bps).

Rising oil prices led to concerns that the disinflation process may slow, at least in the short term, adding downward pressure on bond prices -- which move inversely with yields. Oil prices climbed on Tuesday for the fourth consecutive session as weak shale output in the United States spurred further concerns about a supply deficit stemming from extended production cuts by Saudi Arabia and Russia.

Euro zone consumer inflation in August was slightly lower than initially estimated. Italy' 10-year bond yield -- the benchmark for the euro area's periphery -- was down 3 bps at 4.49%.

The spread between Italian and German 10-year bond yields – a gauge of investors' confidence towards the euro area's most indebted countries – was at 177 bps after hitting a fresh 3-1/2 month high at 180.90 bps on Monday. ECB policy hawks reiterated the central bank needs to end reinvestments from bonds bought under the 1.7 trillion euro ($1.82 trillion) Pandemic Emergency Purchase Programme (PEPP) earlier than the current end-2024 deadline.

Such a move might hurt peripheral bond prices as the ECB can flexibly use PEPP reinvestments to avoid excessive yield spread widening, which might hamper the monetary policy transmission.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)