Euro zone government bond yields edged higher on Friday, not far off their multi-week highs as the market paused ahead of Federal Reserve chair Jerome Powell’s speech at Jackson Hole.
Most analysts argued Powell’s speech is unlikely to trigger a further sell-off in bonds as the Fed leaned hard on the idea that rates would rise and remain at a high level until inflation returned to the 2% target, despite recession risks.
Fed officials on Thursday were noncommittal about the size of the interest rate increase they will approve at their Sept. 20-21 meeting.
“It will be interesting to see which of these two (Powell’s possible) messages press headlines and market participants will regard as more important: the strong inflation-fighting commitment or the message that the pace of tightening will slow down at some point in the future,” Unicredit analysts said.
Germany’s 10-year yield, the bloc’s benchmark, rose 2.5 basis points (bps) to 1.34%, after hitting its highest level since early July on Thursday at 1.39%.
Deutsche Bank economists said in a note they “think he (Powell) will likely skew his remarks in a hawkish direction to ensure the Fed’s inflation-fighting credentials are unquestioned, not least after the comments from July were interpreted in a dovish light.”
Meanwhile, futures on gas prices, which have recently been in the spotlight, kept fluctuating around their highest levels since early March. They were at 303 euros per megawatt-hour (MWh) on Friday after hitting an almost six-month high at 322 euros the day before.
Analysts flagged a positive correlation between euro zone yields and the energy price, as the latter is seen as a proxy of future inflation.
Italian bond prices outperformed their peers on Friday after underperforming the day before, with the 10-year yield up 7 bps to 3.62%, while the spread between Italian and German 10-year yields widened to 227 bps.
The Italian-German spread widened from 210 bps to around 260 bps after the government led by former ECB president Mario Draghi collapsed last month. It tightened in the following weeks as Pandemic Emergency Purchase Programme (PEPP) reinvestments data showed significant support for the peripheral bond markets of Italy and Spain in July.
Giorgia Meloni, seen as the front-runner to become Italy’s first woman prime minister after the Sept. 25 elections, said on Thursday the Italian rightist alliance’s ambitious spending plans would respect European Union budget rules.
Analysts recently argued that right-wing parties’ pledges of significant tax cuts and higher pension spending might eventually put Italy on a collision course with Brussels. (Reporting by Stefano Rebaudo, Editing by Subhranshu Sahu)