European Bond Markets See Bear Steepening Amid Real Rate Rise

... as well as in EUR

The bear steepening is not confined to the US. In Europe the 10y Bund yield briefly pushed past 2.8% and the 30y hit 3%. Interesting to note is that this happened with longer term inflation expectations actually dropping, so entirely real rate driven.

Risk assets of course are not liking it. In European sovereign space this has seen Italian bond spreads over Bunds prolonging their widening leg, taking the 10y spread to 186bp today. But overall widening was a moderate 2bp in relation to the 5bp outright move today, also considering it was largely directional widening since the start of this month. But at the same time that widening over the past week also happened alongside implied rates volatilities coming down, which should normally support spread products.

Implied volatility has picked up a tad over the past few sessions but still remain at their lowest since June. In part, it may be the explanation why Bund asset swap spreads (ASW) have remained relatively tight as they mirrored that broader move. That is still notable though, as a lot of the factors traditionally driving the Bund ASW are on the move, and pulling in different directions.

Risk sentiment as measured by sovereign spreads has been one factor, but its influence seems muted, with other risk measures like volatility being down. The European Central Bank’s chatter about quantitative tightening has become louder, but the additional effective net supply that a speedier unwinding of the ECB’s bond portfolios implies may take more time to actually realise. More near term, supply could actually still drop, when the German debt agency updates its quarterly funding plan today. And starting next week government deposits currently still sitting on the Bundesbank’s balance sheet will no longer be remunerated and could hence push into the market for high quality collateral.

 

10Y yields are on long term highs, but the curves still have room

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Today's events and market views

The data calendar for the US already gets busier with the releases of house price data, new home sales numbers and the Conference Board consumer confidence survey as highlights today. The European data calendar has less on offer but we will see quite a few ECB officials making public appearances, including chief economist Lane and Austria’s Holzmann.

Government bond primary markets will stay busier with a 10Y tap out of the Netherlands, a 5Y tap from Germany and Italian short term plus linker auctions. The main highlight will probably be the release of the German fourth quarter funding plan with cuts to the issuance target expected.

The UK taps its 10y green Gilt and the US Treasury sell a new 2Y note.