Global Market: Eurozone bond yields set for weekly decline as ECB hike bets ease

Eurozone benchmark bond yields were on track for their first weekly decline since early August on Friday, as investors scaled back expectations for further European Central Bank interest-rate increases following a sharp rise in global borrowing costs.

Money markets were pricing the ECB's deposit rate at around 2.86% by December, compared with the current 2.50%, implying almost a 50% probability of a second rate hike before the end of the year. By November 2027, the expected rate had eased to 3.39% from 3.55% on Monday.

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The move came as investors reassessed the outlook for monetary policy following a week of major central-bank decisions. The U.S. Federal Reserve raised interest rates on Wednesday and adopted a more hawkish stance, while the Bank of England kept rates unchanged but warned that elevated energy prices could intensify inflation pressures. ECB has also signalled further tightening risks after raising borrowing costs last week.

Germany's 10-year government bond yield rose 0.5 basis points to 3.49% on Friday. It had climbed to 3.5723% on Tuesday, its highest level since June 2009, but remained on track for a weekly decline of around 2 basis points.

In contrast, Germany's two-year yield, which is more sensitive to expectations for ECB policy rates, was little changed at 3.23%. It touched 3.3123% on Monday, its highest since September 2023, and was headed for a weekly increase of about 5 basis points.

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The divergence between longer- and shorter-dated bonds reflected shifting expectations over the pace and extent of monetary tightening. Reuters has reported that some market participants believe rate-hike expectations have moved too far, with elevated energy costs potentially weakening economic growth and eventually reducing inflationary pressures.

Treasury yields stabiliseThe benchmark 10-year U.S. Treasury yield was broadly unchanged at 4.94% on Friday after falling about 6 basis points on Thursday. It had breached 5% earlier in the week, reaching 5.041%, its highest level since July 2007.

Longer-dated Treasury yields found some relief after Fed Chair Kevin Warsh reinforced the central bank's focus on bringing inflation back toward its target. The Fed's September rate increase was its first in more than three years, while 16 of 18 policymakers projected at least one additional hike by the end of 2026.

Investors nevertheless continued to price a more aggressive rate path than indicated by the Fed's official projections. This has kept pressure on global bond markets as investors weigh persistent inflation against the potential economic damage from higher borrowing costs.

France, Italy spreads remain elevatedFrance's 10-year government bond yield rose 0.5 basis points to 4.45%, after reaching 4.5531% on Tuesday, its highest since September 2008.

The spread between French and German 10-year yields stood at 96.50 basis points, having widened to 98.15 basis points on Tuesday, its highest level since July 2012.

Bond-market pressure has coincided with political and fiscal concerns in France, where Prime Minister Sebastien Lecornu is working to finalise a 2027 budget aimed at reducing the deficit amid voter concerns over the rising cost of living.

Italy's 10-year government bond yield was little changed at 4.35%, leaving the spread over German Bunds at around 86 basis points.

Oil prices remain key to rate outlookEnergy markets remained a major focus for bond investors. Brent crude futures were heading for a third consecutive session of declines as concerns over potential disruptions to Saudi supplies eased.

Brent prices fell on Friday as hopes grew for alternative routes for Middle Eastern oil supplies, while broader market sentiment improved. Prices, however, remained above $100 a barrel amid continuing geopolitical tensions.

ECB Vice President Boris Vujcic also cautioned against assessing monetary policy solely through the lens of energy prices. In comments to Reuters, he said policymakers would consider a broader range of economic indicators, while acknowledging that persistently high energy costs could eventually weaken household incomes, consumption and economic growth.

The combination of elevated energy prices, inflation risks and weakening growth expectations is therefore leaving bond markets caught between expectations of further monetary tightening and concerns that higher rates could eventually weigh heavily on economic activity.

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