Eurozone bond yields surge 6 bps as ECB rate hike bets intensify

Eurozone sovereign bond yields surged Wednesday, with Germany's 10-year Bund climbing 6 basis points to 3.035%, as traders priced in near-certainty of a European Central Bank rate hike this month after hopes for a US-Iran deal faded.

"This is the third energy crisis for Europe since 2000. We had COVID, Ukraine, Iran, each one of these crises required fiscal spending because governments need to support the industry and the consumer," said Yoram Lustig, head of global investment solutions at T. Rowe Price. "This is bad for government bonds."

Germany's 2-year yield, the most sensitive to rate expectations, rose 5.1 basis points to 2.671%, while the 30-year Bund yield added 5.2 basis points to 3.572%. Italy's 10-year BTP yield jumped more than 8 basis points to 3.755%, pushing the spread over German Bunds to 72 basis points. The 2-year to 10-year yield curve steepened to 36.25 basis points. Money markets now price about 65 basis points of ECB tightening this year, up from roughly 55 basis points Friday, with a rate increase at the June 11 meeting seen as almost certain. The ECB's main refinancing rate currently stands at 2 percent.

The selloff compounds pressure on eurozone governments already contending with higher borrowing costs. The last time Germany's 10-year yield traded above 3 percent was in late March, when it reached 3.13 percent — the highest since June 2011. A sustained rise in yields would tighten financial conditions across the bloc, potentially weighing on equities and strengthening the euro, while widening spreads on Italian debt signal renewed stress in the region's more indebted economies.

The bond rout accelerated after the US struck Iranian military sites over the weekend and Iran's Revolutionary Guards retaliated, targeting a US base. Brent crude oil rose more than 5 percent to trade near $98 a barrel, adding to inflation concerns that could force the ECB to act more aggressively. Israeli Prime Minister Benjamin Netanyahu ordered attacks on Beirut's Hezbollah-controlled southern suburbs Monday, with both sides accusing each other of ceasefire violations.

The geopolitical turmoil has revived memories of the 2022 energy crisis that followed Russia's invasion of Ukraine, when European bond yields spiked and the ECB was forced to create the Transmission Protection Instrument to contain peripheral spreads. The current BTP-Bund spread at 72 basis points remains well below the 250-basis-point levels seen during that period, but the trajectory is drawing attention from policymakers.

Rate Path Hinges on Inflation Outlook

The ECB's June 11 decision will be the first test of whether the central bank can look through energy-driven inflation spikes. The deposit rate at 2 percent leaves limited room for further tightening before the economy — already showing signs of strain — absorbs the impact. Italy's services sector data showed costs at a three-year high even as business activity contracted, a stagflationary mix that complicates the ECB's communication strategy. Traders will scrutinize President Christine Lagarde's press conference for any signal on the September meeting, where another quarter-point move is currently priced in.

The US employment report due Friday will provide the next major data point for global rate expectations. A stable labor market would reinforce bets that the Federal Reserve holds rates steady into next year, while a hot print could compound the bond selloff by tightening dollar funding conditions worldwide. The euro traded weaker against the dollar as the yield differential between US and German 10-year bonds widened to about 147 basis points, reflecting the relative divergence in monetary policy expectations.

This article is for informational purposes only and does not constitute investment advice.