European yields edge higher, extending recent rise

U.S. markets were closed on Monday for Labor Day, which typically marks the start of a post summer resumption in bond issuance. The move higher in yields came even as expectations for rate hikes on either side of the Atlantic retreated, in the U.S. thanks to weaker payrolls data.

Euro zone bond yields rose on Monday, extending a U.S.-led move from late last week. Germany's 10-year yield, the benchmark for the euro zone, rose 3.5 basis points (bps) to 2.58% after a 7.4 bp jump on Friday.

Italy's 10-year yield, the benchmark for the euro zone periphery, rose 6 bps to 4.30%, after an 11 bp jump on Friday, with both yields largely in the middle of their ranges for the year. A speech by European Central Bank President Christine Lagarde failed to trigger any price action.

Friday's move higher in European yields mirrored U.S. Treasuries where a rally in bonds after weaker jobs data reversed course. Bond yields move inversely to prices.

"The most convincing argument that we can see for this sudden back up in U.S. yields, which spilled over into Europe, is the market bracing itself for a sizable slug of corporate supply," said Richard McGuire, head of rates strategy at Rabobank. U.S. markets were closed on Monday for Labor Day, which typically marks the start of a post summer resumption in bond issuance.

The move higher in yields came even as expectations for rate hikes on either side of the Atlantic retreated, in the U.S. thanks to weaker payrolls data. Current market pricing indicates roughly a 30% chance that the ECB raises rates by 25 basis points in September. The chance of one further hike by year end is finely balanced.

These expectations could be disrupted by several public remarks this week from ECB policymakers ahead of their meeting on Sept. 14. For the first time in over a year, traders are struggling to gauge whether the ECB will raise interest rates. "The sharp intraday curve moves on Friday show that market liquidity continues to increase after the summer, and investors are adjusting their positioning ahead of the key ECB and Fed meetings," said Rainer Guntermann, strategist at Commerzbank.

Policymakers must assess whether a further rate hike is necessary to ensure inflation is falling back towards target or whether inflation is already cooling, and another increase would cause unnecessary damage to the stuttering European economy. Investor morale in the euro zone fell more than expected at the start of September as Germany's economic weakness remained a major drag on the region, a survey showed on Monday.

Germany's two-year yield was up 3 bps at 3.02% and Italy's two-year yield was up 4.5 bps at 3.74%.