Key Takeaways:
Eurozone government bonds tumbled across the curve Tuesday as traders locked in bets the ECB will raise rates to 2.25% on Thursday.
European government bonds sold off across the curve Tuesday, pushing Germany's two-year yield up 5 basis points to 2.718%, as traders priced a near-certain 25-basis-point rate hike from the European Central Bank on June 11.
"The bond selloff reflects a market that has fully capitulated to the reality of a rate hike, driven by the Iran war's persistent impact on energy costs," said Jens Peter Sorensen, chief analyst at Danske Bank AS.
France's two-year yield jumped 6.2 basis points to 2.909%, the largest move among major eurozone sovereigns, while Italy's 10-year yield rose 4.9 basis points to 3.850%. Spain's 10-year yield added 4.1 basis points to 3.521%, and Greece's climbed 5.4 basis points to 3.808%. The German 10-year bund yield, the benchmark for the region, rose 3.4 basis points to 3.076%, extending its year-to-date advance as the bloc grapples with higher defense spending and a deteriorating growth outlook.
The selloff comes a day before the ECB's June 11 decision, where futures markets imply a roughly 97% probability of a quarter-point increase to 2.25%, according to Bloomberg data. With eurozone inflation accelerating to 3.2% in May — well above the 2% target — and the S&P Global composite PMI contracting for a second straight month at 48.5, the central bank faces the risk of tightening into a slowdown, a scenario that could deepen the region's stagflationary tilt.
Rate Differentials Widen as Core Yields Reprice
The two-year German yield has climbed roughly 50 basis points since early April, when the Iran conflict first sent oil prices surging. The 2/10-year German yield spread narrowed to 35.5 basis points, reflecting a classic bear-flattening pattern where short-dated yields rise faster than long-dated ones as rate-hike expectations intensify. The last time the ECB faced a comparable inflation-driven tightening cycle was in mid-2022, when the deposit rate was lifted from zero to 4% over 14 months — a pace that ultimately contributed to a mild recession in the eurozone's manufacturing heartland.
Sovereign Supply Adds to the Pressure
The bond selloff is unfolding against a backdrop of record sovereign syndicated issuance. Governments have sold $504 billion of syndicated bonds so far this year, surpassing even the pandemic-era first half of 2020, according to Bloomberg-compiled data. Italy, the most active user of the market, has raised nearly €70 billion in the first six months. Germany, which rewrote its fiscal rules to fund a defense and infrastructure splurge, has raised €14 billion from three syndications. The combination of rising rate expectations and swelling supply is compressing the premium investors demand to hold longer-dated paper, making the curve more vulnerable to further steepening if the ECB signals additional tightening in September.
More than 60% of economists surveyed by Reuters expect a follow-up hike in September, which would bring the deposit rate to 2.50%. BNP Paribas Asset Management's base case calls for two quarter-point increases — in June and September — followed by an extended hold through end-2027. The ECB's updated macroeconomic projections, due alongside Thursday's decision, will be critical: if inflation estimates for 2026 and 2027 are revised significantly upward, as DWS senior economist Ulrike Kastens expects, the case for a September hike will harden, keeping yields elevated through the summer.
This article is for informational purposes only and does not constitute investment advice.
