Upheaval in Euro area bond markets

There was a flight to the ‘safety’ of German bonds yesterday amid a sell-off in French and Italian bond markets, with yields in the latter spiking higher and spreads over Germany widening out sharply. European equity markets also came under pressure, underperforming the US by some distance, while the euro lost ground across the board, falling to a fresh 2026 to date low of $1.1215 versus the dollar in the process. The single currency is trading at around $1.1260 and £0.8520 against the dollar and sterling respectively this morning, with GBPUSD hovering just above $1.32, ahead of the September employment (payrolls) report in the US later today. A stronger than expected report would almost certainly see the dollar extend its gains, while a weaker report could see it give up some ground. Euro area inflation data for September are due this morning – headline inflation is likely to have risen quite sharply last month on the back of higher energy prices.

The turmoil in Euro area bond markets saw expectations for ECB rate hikes pared back with a 25bps increase before the end of the year no longer seen as a done deal. Amid a ‘flight to safety’, German 2-year bond yields plunged by almost 15bps while 10-year yields fell by almost 10bps. Equivalent French and Italian yields spiked higher – increasing by 8-12bps – amid ongoing fiscal/budgetary concerns in the former and worries about the survival of the government in the case of the latter. US bond yields fell by around 10bps and 5bps in the 2- and 10-year area respectively, with some dovish ‘Fedspeak’ contributing to the move lower. In equity markets, European stocks sold off quite sharply – the Stoxx Europe 600 shed almost 1.5% – while US indices closed with small gains.

Comments by Fed member Jefferson suggest the central bank is not in a hurry to raise interest rates again following last month’s 25bps hike. He says that “any future adjustments in policy should be determined by carefully examining trends in the data, the evolving (growth and inflation) outlook, and the balance of risks,” noting that “my colleagues and I will need to come to our own judgment (on interest rates), which may take more time.” The market is currently pricing in a slightly less than 30% chance of a rate hike at this month’s meeting, but still fully expects a 25bps increase by the end of the year.

For today, as mentioned, the key economic data release is the September employment report in the US. According to the consensus forecast, the economy is expected to have added 90k jobs last month (after +162k in August) with the unemployment rate and y-o-y earnings growth both seen unchanged from August at 4.1% and 3.1% respectively. The flash inflation reading for September in the Euro area, also due today, is expected to show headline inflation accelerated to 3.7% last month from 3.2% in August, but core inflation is seen nudging up only slightly, to 2.5% from 2.4% in August.