European Government Bond Market Roiled By Inflation, ECB Policy
2022.06.21 12:06
Irish Finance Minister Paschal Donohoe, who heads the so-called Eurogroup of EU finance ministers, felt obliged this week to reassure bond market investors that the eurozone does not face another debt crisis like the one a decade ago.
His comments came after the European Central Bank governing council held an emergency meeting last week and pledged measures to keep spreads in sovereign bonds from growing to the point that the central bank could no longer conduct effective monetary policy.
Italy 10-year vs Germany 10-year spread
After the ECB neglected to detail any supportive measures following its regular policy meeting the week before, European investors sold off Italian government bonds, pushing yields on the 10-year bond above 4% and widening the spread with German bonds to levels not seen since emergency bond purchases were initiated at the start of the pandemic.
The ECB’s pledge to provide some relief by diverting funds to buy bonds of highly indebted countries like Italy and Spain calmed markets and reduced the spread between Italian and German bonds.
Donohoe was right that European banks, including those in Italy, are in a stronger position now than they were 10 years ago, but Europe is facing new challenges as well from surging inflation and the war in Ukraine.
France 10-year vs Germany 10-year spread
French bonds were dealt a body blow as newly re-elected French President Emmanuel Macron lost his majority in parliament with the second round of legislative elections Sunday. His centrist alliance won only 245 seats in direct voting by constituencies, only 38.6% of the 577 seats and far short of the 289 needed for a majority.
Also bad for bond yields, the far-right National Rally led by Marine Le Pen won a record 89 seats in a last-minute surge, while a left-green alliance headed by Jean-Luc Mélenchon obtained 131 seats.
This result pushed up yield on the 10-year French bond more than 10 basis points Monday, to 2.31%—not much, but more than weak southern nations like Spain, Portugal, and Italy. The spread between French and German 10-years widened to about 58 bps, compared to only 30 at the beginning of the year.
Macron will have a lot more trouble pushing through any reform agenda without the large majority he had enjoyed until now (he had difficulty with pension reforms even before amid pitched riots in the street).
However, German bond yields rose sharply on Monday as the powerful IG Metall labor union, which represents auto workers and other industries, said it will seek wage hikes of 7% to 8% in the next bargaining round.
The German 10-year yield rose more than 8 bps to 1.745%, keeping the spread to Italy’s 10-year yield to below 200 bps despite a sharp rise in the Italian bond yield.
US 10-year Weekly Chart
US Treasuries took a back seat to European developments, especially with markets in the US closed to observe the Juneteenth holiday. Yield on the benchmark 10-year note was down 8 bps Friday, to 3.226%, after the Fed’s 75-basis-point hike last week.
Other central banks joined the Fed, with the Swiss central bank raising rates for the first time in 15 years, by a half-point, and the Bank of England deciding on its fifth quarter-point rate hike in a row.
