German Bunds Outperform as Oil and Political Risks Rise

German Bund yields were little changed at 3.5%, while borrowing costs in more indebted euro-area countries surged as investors sought safe-haven assets amid a rebound in oil prices and persistent fiscal and political uncertainty across Europe. Brent crude rose back above $100 a barrel as Iran intensified attacks on shipping in the Strait of Hormuz, reinforcing expectations for further rate hikes from major central banks. The ECB is now seen hiking twice more by March 2027, while swaps price around 75 basis points of tightening by the end of next year. Meanwhile, French bonds remain under pressure as political uncertainty ahead of the 2027 election raises concerns over the country’s finances. The minority government has unveiled a deficit-reduction plan, though the fiscal watchdog warned its economic assumptions were “optimistic.” Political uncertainty is also rising elsewhere, with Spain calling a snap election for November 29 and Italy heading to the polls next year.

Germany’s 10-year Bund yield fell to 3.45%, retreating from the 17-year highs reached last week, as turmoil in bond markets prompted investors to scale back expectations for further ECB rate hikes. Markets are now pricing in an 80% probability of another rate increase by year-end. Whereas investors had previously expected at least three further hikes by March 2027, they are now fully pricing in just one additional move, with roughly an 80% chance of a second. ECB Chief Economist Philip Lane said on Monday that the recent surge in borrowing costs could weigh on the economy by curbing demand, potentially reducing the amount of further tightening needed to contain inflationary pressures. Meanwhile, the France-Germany 10-year yield spread narrowed further as investors reassessed whether France’s recent jump in risk premium had been excessive. In Spain, Prime Minister Pedro Sánchez called a snap election for November 29 following protests over rising housing costs.

Germany’s 10-year Bund yield fell to 3.412%, its lowest level since September 8, extending the decline for a fifth consecutive session as investors sought the relative safety of German government debt. Demand has been supported by renewed concerns over sovereign risk in the Eurozone, particularly following last week’s sharp bond-market sell-off. France remains a key source of uncertainty, with investors questioning the government’s ability to reduce its budget deficit and secure parliamentary backing for its fiscal plans ahead of next year’s election. Political concerns have also spread to Spain after PM Sánchez called a snap election following Congress’s rejection of housing measures. At the same time, Eurozone inflation accelerated to 3.8%, the highest since September 2023 and well above the ECB’s 2% target, largely due to higher fuel prices. Markets now expect one 25-basis-point rate hike by December, with a smaller chance of another, and see the deposit rate near 3.4% by late 2027.