Euro zone government bond yields rose on Wednesday on hopes of progress in peace talks over Ukraine while markets waited for the outcome of the Federal Reserve policy meeting.
Risky assets jumped on rising hopes Beijing will roll out more economic stimulus, while investors continued to watch Ukraine-Russia peace talks and the Fed.
Analysts said the rise in yields was more related to the news coming from Ukraine, which has boosted risk sentiment. Markets believe peace is possible as there seems to be better communication, and both sides seem to be willing to negotiate.
Germany’s 10-year government bond yield, the euro zone benchmark, rose 5.5 basis points (bps) to 0.388%, its highest since November 2018.
Investors were still wondering about the impact of the war in Ukraine and if risks of stagflation might trigger a more dovish stance from the European Central Bank.
ECB Vice-President Luis de Guindos on Tuesday said rising inflation would continue to impact the European Union but that the bloc's economy would not go into recession.
Bond yields jumped last week after the ECB decided to speed up a reduction of its bond purchase programme despite uncertainty about the economy due to the war in Ukraine.
However, ECB president Christine Lagarde said on Tuesday if the medium-term inflation outlook changed, and if financial conditions became inconsistent with further progress towards the ECB’s 2% target, the bank was ready to revise its schedule for net purchases in terms of size and duration.
Italy's 10-year government bond yield rose 2 bps to 1.925%, with the spread between Italian and German 10-year yields tightening to 153 bps.
The Fed is expected to close the door on its ultra-easy pandemic-era monetary policy and step up the fight against stubbornly high inflation with the first in what is likely to be a series of interest rate hikes this year.
ING analysts expect “the Fed to hike by 25bp today and signal 90bp of extra tightening this year in its Dot Plot projections.”
Money markets continue to price in about 170 bps worth of Fed rate hikes by December 2023.
But investors seem to be more focused on how the U.S. central bank plans to end its bond-buying programme and the future pace of reinvestments.
“Markets are already yearning for guidance on the way forward, judging by the remarkable rates and curve volatility heading into the meeting,” Commerzbank analysts said in a note to clients.
“While stagflation fears are hard to dismiss and quantitative tightening could drive the policy tightening eventually, our economists expect the macro backdrop to stay sufficiently resilient to keep the FOMC going,” they added.
(Reporting by Stefano Rebaudo, editing by Mark Potter)