Two-year German yields set for biggest daily jump since 2008

On Monday, ECB President Christine Lagarde said market turmoil may dampen demand and inflation but that interest rates would still be the main tool to fight rising prices. The August 2023 ECB euro short-term rate forward was around 3.247% implying expectations for a deposit rate peak at 3.347% by then, or the equivalent of just over one more 25 basis point hike.

Short-dated euro zone bond yields jumped on Tuesday, calmed by central banks' efforts to shore up liquidity, and as the focus turned to the Federal Reserve's two-day policy meeting that begins later in the day. Germany's two-year yield, which is the most sensitive to changes in interest rate expectations, was last up 26 bps at 2.578%, on track for its biggest daily jump since September 2008, during the global financial crisis. It hit a 14-week low of 2.089% on Monday.

Bond yields move inversely with prices. On Sunday, the Fed and five other major central banks, including the European Central Bank, took coordinated action to bolster dollar liquidity throughout the global financial system with a new daily currency swap facility.

Euro area banks have borrowed just $10 million from the ECB's facility in the two operations since Monday, providing reassurance that banks in the bloc have no pressing need for extra dollars. "The lack of demand ... probably triggered the relief, highlighting that dollar liquidity provision is not seen as the problem at the moment," Commerzbank rates strategists said in a note.

Expectations for interest rate increases have picked up marginally, after bets were scaled back over the last two weeks for how far the ECB might raise interest rates. On Monday, ECB President Christine Lagarde said market turmoil may dampen demand and inflation but that interest rates would still be the main tool to fight rising prices.

The August 2023 ECB euro short-term rate forward was around 3.247% implying expectations for a deposit rate peak at 3.347% by then, or the equivalent of just over one more 25 basis point hike. It fell below 3% on Monday. The November 2023 forward had peaked above 4% before fears of a banking crisis started to hit the markets on March 9.

"We have seen the market over-interpret what the ECB is going to do in both directions," Daniel Lenz, head of euro rates strategy at DZ Bank, said. "With no negative news flow, I would expect markets to begin pricing in further rate hikes. The market is pricing just one step at the moment and that is far too low," Lenz added.

Germany's 10-year yield, the benchmark for the euro area, was last up 17 basis points (bps) at 2.268%. It hit a more than 13-week low of 1.923% on Monday. Italy's two-year yield was up 13 bps at 2.9918%.

Italy's 10-year yield rose 11 bps, pushing the closely watched 10-year yield gap between German and Italian bonds to a more than one-week low of 179.2 bps earlier. The focus shifted to the Fed's policy announcement on Wednesday, with markets split on whether the central bank will raise its benchmark policy rate.

Fed funds futures price in a more than 80% chance of a 25-bp rate rise with just under a 20% probability of no change. Two weeks earlier, market pricing suggested a 50-bp rise was the most likely outcome.

"A 50 basis point rate hike would be too much in this environment but no rate hike would could be interpreted as the Fed knowing something that we don't," DZ Bank's Lenz said. "That's why, despite the inflation and problems the U.S. is facing, we expect a 25 basis point rate rise from the Fed."

 

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