Euro zone bond markets back on rate hike watch

LONDON — European bond markets on Thursday were again positioning for an early European Central Bank rate hike next year, a day after data showing the biggest annual rise in U.S. consumer prices in 31 years boosted U.S. rate hike bets.

After selling off sharply with U.S. Treasuries when Wednesday’s inflation data showed the U.S. consumer price index jumped 6.2% year-on-year in October, calm returned to euro zone bonds. U.S. markets were closed for a holiday.

Still, 10-year bond yields across the bloc held above lows hit in the past week, driven by central banks including the ECB talking down aggressive market pricing on rates.

Italy’s 10-year bond yield was up 2 basis points (bps) at 0.95% by 1552 GMT, having jumped almost 10 bps on Wednesday.

Bund yields were up nearly 2 bps to -0.23% after rising nearly 3 bps earlier in the session.

Money-market pricing also reflected a swing back to investors positioning themselves for rate hikes coming sooner rather than later.

Eonia futures dated to the ECB’s September 2022 meeting fully price in a 10 bps rate rise, having earlier this week positioned for a move in December 2022. They also priced in a strong chance of second 10 bps hike by end-2022.

U.S. money markets now price a first Fed interest rate increase by July.

“Today’s U.S. market closure offers a faint hope of less volatile market conditions but we wouldn’t hold our breath,” said ING senior rates strategist Antoine Bouvet.

“If the ECB’s dovish message seems to have landed on euro zone bonds, contributing to a ‘re-anchoring’ of front-end rates of sorts, they are not immune to global developments.”

Volatility in bond markets has picked up as investors try to assess what a short-term jump in price pressures fueled by factors such as supply bottlenecks mean for the longer-term outlook and central bank policy.

Market gauges of inflation expectations on both sides of the Atlantic are pushing higher again as well, with the five-year U.S. breakeven inflation rate on Wednesday reaching a record-high 3.113%.

Edmund Shing, BNP Paribas Wealth Management CIO, said that even if inflation does come down, it is likely to remain higher for longer, posing a challenge for central banks.

“Over the last few years, it was very simple: You turn the tap on for liquidity, you never turn it off. Now the question is, do we turn it down a little bit or not?,” he said.

“There are certainly questions about the duration of the bull market in bonds,” said Shing. “People say ‘equities have been doing so well for 10 years’, well bonds have done well for 35 years. That’s the bull market I’m worried about.”

(Reporting by Dhara Ranasinghe Additional reporting by Brenna Hughes Neghaiwi in Zurich Editing by Timothy Heritage and Mark Potter)