European government bonds reversed on Thursday, rising after falling sharply in the previous session, as a fragile Middle East ceasefire continues to keep markets on edge.
Bond traders have been plagued by unusually high volatility, which has clouded the outlook for interest rate policy from the Bank of England and the European Central Bank.
yield 10 years gilts The Treasury Bond, a measure of British government debt, rose more than six basis points to 4.775% on Thursday, after falling 21 basis points the previous day. of 2 year gilt The yield rose 7 basis points to 4.245%, after falling 25 basis points in the previous session.
German federal bonds followed a similar pattern. of 10 year government bond yield It rose nearly 5 basis points to 2.9886% after falling nearly 17 basis points on Wednesday. meanwhile, 2 year bundle The yield, which had fallen 28 basis points in the previous session, recovered 6 basis points to 2.5549%.
Bond yields and prices move in opposite directions, with one basis point equaling 0.01%.
Consider inflation risk
Markets have been in turmoil since hostilities between the United States and its ally Iran began on February 28th. Borrowing costs in several European countries have reached multi-decade highs in recent weeks as soaring oil prices raise inflation concerns and complicate how investors assess future interest rate developments.
Laura Cooper, global investment strategist and head of macro credit at Nuveen, said volatility has become the “new normal” as traders try to separate signal from noise. “Investors can’t ignore every headline, but they can’t trade on everything either,” Cooper said.
UK 10 Year Gilt.
He added that resuming oil and gas shipments through the Strait of Hormuz is critical to limiting lingering economic damage, and said the ongoing turmoil is not an “extraordinary situation” but an “expression” of a changing geopolitical order.
“This development will do little to dampen near-term price pressures, a risk premium remains justified for oil, and there is evidence of supply chain disruptions, the latter of which will take time to resolve,” he told CNBC in an email.
“Inflation risks could limit upside in long-dated bonds until there is evidence of growth destruction, and we have great confidence in a steeper curve…Positioning has become shorter in duration, with curve steepening and inflation protection increasingly preferred over outright bets on interest rates.”
Dan Coatsworth, head of markets at AJ Bell, said a rate hike was still likely but could be smaller than expected before Tuesday night’s ceasefire announcement.
“Any signs of oil prices rising again could lead to further declines in the bond market,” Coatsworth told CNBC in an email. “There seems to be a lot of optimism in the market right now that the Iran crisis is nearing an end, but it’s too early to tell. We’re in a difficult situation.”
Brent crude oil.
Global oil prices rose again on Thursday, but are still far from recent highs. international benchmark brent crude oil In the United States, oil prices rose more than 3% to $97.60 per barrel. west texas intermediate Prices rose 4.3% to $98.53.
A prolonged period of high oil and gas prices is expected to hit Europe, a net energy importer, harder than other regions.
Nicholas Brooks, head of economics and investment research at ICG, said policymakers were now closely monitoring how energy costs would be transmitted through the economy through inflation expectations, wages and core price indicators.
Investors are bracing for interest rate hikes
Markets are currently pricing in a 25 basis point (bp) rate hike from the Bank of England this year, down from 50 basis points (bp) before the ceasefire. The ECB is expected to hike rates twice this year, reflecting the ECB’s room to raise rates following sustained rate cuts from their peak in mid-2024.
“While markets are still pricing in rate hikes, we think it would be prudent for the central bank to take a wait-and-see approach to policy rather than reacting prematurely, given that both the UK and euro area economies have more headroom than during the last inflationary phase in 2022,” Brooks said.
German 10 year bond.
Matthew Amis, interest rate management investment director at Aberdeen Investments, said the ceasefire was “definitely good news” but warned “things are not over yet”.
Amiz said European and British government bonds now have some value, although they have seen a sharp reversal in sentiment since the conflict began. However, he added that the move lower in yields is unlikely to be smooth as the market has to weather a “headline-heavy” period in the coming weeks.
“Yields may continue to fall, but markets will remain on high alert,” Amis said. “We have been tentatively dialing back risk over the last week or so because we thought the market was pricing in too many rate hikes. We are happy to hold off here. If the positive news flow continues, rate hikes could continue to be priced in in both the UK and EU.”
