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German 10-year yield touches new high before Fed meeting

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Euro zone government bond yields rose on Monday as investors prepared for another large U.S. Federal Reserve rate hike and several other central bank meetings this week.

The Fed is widely expected to raise rates by 75 basis points (bps) on Wednesday, while markets are pricing in around a 20% chance of a 100 bps hike in a bid to tame inflation.

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“Investors’ focus will be on the new (Fed’s) dot plot of interest-rate projections,” Francesco Maria Di Bella, fixed income strategist at UniCredit, said.

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The Bank of Japan and Bank of England also meet this week.

Germany’s 10-year yield, the benchmark of the bloc, rose to a new high since mid-June at 1.818% and was up 3 bps to 1.80% by 1443 GMT.

European Central Bank chief economist Philip Lane added to the hawkish sentiment by saying it could raise interest rates next year, causing pain for consumers as it tries to depress demand that is adding to sky-high inflation.

“While ECB terminal rate expectations are already flirting with 2.75% by May, the short-end looks set to remain under pressure with ECB members suggesting that a mild recession will not stand in the way of several more major tightening steps,” Commerzbank analysts said in a note to clients.

Germany’s 2-year yield, more sensitive to rate hikes, rose as high as 1.614%, nearing an 11-year high of 1.62% hit last Friday.

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“We expect the spread between U.S. and German 10-year yields to fall towards 150 bps in the next few months as the ECB started its tightening path later than the Fed,” UniCredit’s Di Bella added.

The gap was around 169 bps on Monday.

Analysts said a so-called “curve flattening bias” remained intact. This means longer-dated bond yields are falling faster or rising slower than shorter-dated ones, signaling investor caution about the economic outlook.

The gap between 2- and 10-year German yields was at 20 bps, after hitting its narrowest since January 2021 at 16.3 bps last week, when the gap between 10- and 30-year yields inverted for the first time on record.

Italy’s 10-year government bond yield also rose to a fresh 3-month high at 4.12%, with the spread between Italian and German 10-year yields last unchanged at around 226 bps ahead of general elections due on Sept. 25.

The absence of the anti-euro rhetoric seen in the 2018 election has reassured investors, but pressure on bonds could build as focus shifts to budget policy in 2023.

Meanwhile, Spain hired a syndicate of banks to sell a new 20-year bond, a lead manager memo seen by Reuters shows.

It will be launched “in the near future subject to market conditions,” the memo said, a phrase debt management offices usually use a day before issuance.

(Reporting by Stefano Rebaudo, additional reporting by Yoruk Bahceli; editing by Ed Osmond, Raissa Kasolowsky and Alexander Smith)

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