European Bond Rout Deepens on Inflation Worries

European government bonds extended their sell-off in early September, with Germany’s 10-year Bund yield climbing above 3.3% for the first time since May 2011. French yields rose to their highest level since November 2008, while Dutch yields reached 15-year highs and Italian and Spanish yields climbed to near two- and three-year highs, respectively. The renewed pressure on sovereign debt came as rising oil prices and increasingly hawkish signals from major central banks reinforced expectations for higher interest rates. Markets are now pricing the ECB’s deposit rate at around 2.7% by December, implying roughly an 80% probability of a second rate hike after an expected move as early as September. Meanwhile, Fed Chair Kevin Warsh warned that inflation has not slowed meaningfully and that the Fed still has “work to do,” prompting markets to price in a 66% probability of a September rate hike.

European bond yields hit fresh multi-year highs on the final trading session of August, with Germany’s 10-year Bund yield reaching 3.3% for the first time since May 2011. French yields climbed to their highest since November 2008, while Dutch yields hit 15-year highs and Italian and Spanish yields rose to more than two- and three-year highs, respectively, as rising oil prices and hawkish central-bank signals fueled expectations for higher rates. Brent crude rose after the US said it had attacked an Iranian island in the Strait of Hormuz, while Tehran said it had retaliated by targeting US assets in the region. Markets are now pricing the ECB’s deposit rate at around 2.7% by December, implying roughly an 80% probability of a second rate hike following an expected move as early as September. Meanwhile, Fed Chair Kevin Warsh warned that inflation has not slowed meaningfully and that the Fed still has “work to do,” prompting markets to price in a 60% chance of a September rate hike.

German 10-year Bund yields edged above 3.25%, touching their highest level since March 2011, as investors remained concerned about persistent inflationary pressures despite the recent decline in oil prices. Inflation data from France and Spain showed renewed price pressures in August, reinforcing expectations that the ECB could resume raising interest rates at its September meeting. Markets now price the ECB deposit rate at 2.80% by March next year, and around 2.90% by late 2027. Recent ECB minutes suggested officials saw another rate increase as likely necessary, while Reuters reported that policymakers are prepared to hike in September to contain the economic fallout from the Iran war, though they remain reluctant to signal further tightening beyond that. In the US, Fed Chair Kevin Warsh also struck a hawkish tone, warning that inflation has not meaningfully slowed and that policymakers need clearer evidence of easing price pressures, otherwise the Fed still has “work to do.”