Eurozone bonds fall as traders bet on ECB hiking rates

Bonds in the eurozone fell as traders bet that the European Central Bank (ECB) would hike interest rates to a record high. This forecast comes despite indications that inflation across multiple major economies of the region is out of control. 

German 10-year rates are on track to experience their highest daily increase this year. Data released on Tuesday revealed surprisingly higher inflation in France and Spain in February. This data set off the selloff.

Following the economic statistics, traders on the money markets temporarily priced a 4% ECB terminal rate. This is higher than the peak in borrowing costs observed more than two decades ago. Comparatively, 3.5% was anticipated at the beginning of the year. Traders are now speculating that the ECB will continue hiking rates through February 2024.

A string of disproportionate hikes has increased borrowing prices by 300 basis points since July. Despite this, the European economy has been more robust than anticipated. The focus now shifts to euro-area inflation data. It will make an entrance on Thursday. Any indications that there are widespread and entrenched price pressures could ignite speculation regarding additional assertive measures.

Considering recent euphoria, that’s a dramatic change. Traders anticipated the central bank to finish hiking rates by the middle of this year just three weeks ago. Tuesday saw a significant increase in the 2-year German bond yield. It reached a high of 3.20%, or about 80 basis points above the mid-January low.

What are the policymakers’ implications?

The market is too complacent about the future, warn policymakers. They think the market is miscalculating the bank’s determination to bring inflation back to its objective of 2%. In remarks made public on Tuesday, ECB Chief Economist Philip Lane suggested that once borrowing costs peak, the institution might keep them there for a while.

According to data released on Tuesday, France’s consumer prices (FRCPEECY) increased by a record 7.2% from a year earlier. The headline inflation rate in Spain (SPCPEUYY) increased by 6.1%. This excludes energy and fresh food, hitting a record high of 7.7%. Meanwhile, traders have renewed their forecasts for long-term inflation, with one gauge of the market wagering on price growth at its peak. 

Since November, 10-year Treasury rates have not been this low. Apparently, the repricing affected markets outside the eurozone as well. A series of stronger-than-expected US economic statistics challenged the idea among traders that the economy will quickly collapse in response to interest rate increases..

By trading 0.3% higher at $1.0639 as of 2:53 p.m. in London, the euro reversed a prior decline against the dollar.