Euro zone govt bond yields rise over risk of escalating Iran conflict

Euro zone government bond yields rose on Monday after plunging on Friday, with investors still on alert for risks of a broadening conflict in the Middle East, even if recent developments eased fears of an immediate escalation.
 

Iran ended its retaliatory attack with no significant damage to Israel, and the US said it did all it could to avoid an open warfare erupting between the two countries.
 

The 10-year government bond yield, the euro area's benchmark, was up 3 basis points (bps) after dropping 11.8 bps on Friday in its biggest daily drop since Oct. 9, the Monday after the Palestinian Islamist group Hamas' attack on Israel. Bond prices move inversely with yields.
 

"The week is starting on a fraught note, with unease still clouding sentiment. Investors are on alert for retaliatory action following Iran's attack on Israel," said Susannah Streeter, head of money and markets at Hargreaves Lansdown.
 

"Fears are brewing that a dangerous new episode of escalating conflict is about to roll," she added. "All eyes are on diplomatic efforts being made to diffuse the situation." The gap between the 10-year U.S. Treasury and German rates hit a fresh 4-1/2 year high as yields rose more in the U.S. than in the euro area as markets expected the Federal Reserve to be more hawkish than the European Central Bank.

It was at 216.53 after reaching 219.95 early in the session, its highest level since mid-December 2019. It hit on Wednesday its highest since late 2019 for the first time at 214 bps.
 

While Fed officials reiterated there was no urgency to cut rates and supported expectations for two Fed moves this year, European Central Bank rate-setters argued the central bank could ease its monetary policy even if the Fed does not.
 

Lithuanian ECB policymaker Gediminas Simkus said there is a greater than 50% probability of more than three rate cuts this year and Francois Villeroy de Galhau argued that the ECB is increasingly confident that it is winning the inflation fight.
 

Money markets priced in 87 bps of ECB rate cuts in 2024, assigning an around 50% chance to a fourth rate cut this year, and was at the levels seen last week before the U.S. stronger-than-expected inflation data.

Derivatives on U.S. rates price in 45 bps of rate cuts in 2024, discounting an 80% chance of a second rate cut this year from around 50% last week after U.S. data.

"There is a line of thought that if Bund yields experience upward pressure from developments in U.S. Treasuries (as has been the case recently), financial conditions could be overly tight in the euro zone, and the ECB will have to respond with easier monetary," said Rabobank.
 

Italy's 10-year yield, the benchmark for the euro area's periphery, rose 1.5 bps at 3.76%.