Euro zone yields dip as lower gas prices muffle ECB rate-hike drum
LONDON — Euro zone government bond yields fell on Wednesday, shrugging off comments from a European Central Bank policymaker that rates will keep rising, as another drop in energy prices prompted investors to take a more upbeat view of the inflation outlook.
European regional natural gas prices have fallen to their lowest in almost a year and a half this week. Last year, they rose to eye-watering heights after Russia’s war in Ukraine disrupted flows of fuel to the region.
But mild weather, healthy inventory levels and alternative sources of supply to Russia have gradually ground down prices on the global markets, which has been a major factor in setting investor expectations for ECB monetary policy.
On Wednesday, inflation-linked swap rates, which have been declining sharply for the last few weeks, touched their lowest in a year..
“There’s been a little bit of a move lower in inflation swaps in the euro to some extent. Gas prices are a bit lower again today and that might be contributing to an unwind of the move yesterday,” Rabobank rates strategist Lyn Graham-Taylor said.
Yields on German 10-year Bunds fell 8 basis points (bps) to 2.254%, reversing most of Tuesday’s 9-bp rise, while those on the two-year Schatz – the most sensitive to expectations for interest rates and inflation – dropped 2 bps to 2.629%.
A market-based gauge of longer-term inflation expectations was last at 2.35%, having edged down from an eight-month peak of 2.4% in late December.
At a central banking conference in Stockholm on Tuesday, ECB board member Isabel Schnabel indicated rates had further to go from the current 2.0%, given inflation is still running at 9.7%.
“We judge that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to our 2% medium-term target,” she said.
The ECB is forecasting a gradual decline in inflation but only approaching its 2% target within three years.
Europe’s energy crisis, which has unfolded while governments were still battling to contain the economic damage from the COVID-19 pandemic, is one of the drivers of this year’s record wave of new bond issuance.
The German Finance Agency sold 4.508 billion euros of its new 2.3% 10-year Bund for a yield of 2.25%. This was up from the 1.95% achieved at the last auction for paper of this maturity.
This is the first major auction of what will be a monster year for euro zone government debt supply. The U.S. Treasury, meanwhile, auctions 10-year notes and it is this sale that could serve as a key gauge of investor appetite, analysts said.
“Central banks ‘sticking to their (inflation management) knitting’ doesn’t seem to scare bonds any more. Supply does though,” ING strategists led by Padraig Garvey said in a note.
“Even if it’s quiet for euro sovereigns today, pay more attention than usual to the U.S. 10-year auction outcome. The recent flow into money market funds questions the demand for duration. The U.S. 10-year auction will test that,” they said.
Duration is measured in years and refers to how long the holder of a bond must wait for coupon payments and the return of the principal. The higher the duration, the longer the bondholder must wait for repayment.
In a rising rate environment, bond investors tend to reduce the duration of their portfolios. The longer the duration, the higher the losses if rates rise.
Bund yields rose by almost 3 full percentage points in 2022, their biggest annual rise since at least the mid-1950s.
The U.S. Treasury will hold an auction of 10-year notes later. Yields on the current benchmark 10-year note were down 4 bps at 3.579%.
Elsewhere, yields on 10-year Italian BTPs fell 12.5 bps to 4.086%, while two-year yields fell 7 bps to 3.058%.
Beyond the euro zone, investors are awaiting U.S. consumer inflation data for December, which is due on Thursday, and could offer a steer on how quickly U.S. rates are likely to peak. (Reporting by Amanda Cooper; Editing by Toby Chopra and Angus MacSwan)
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